萬豪國際 (MAR) 2006 Q2 法說會逐字稿

Good day everyone and welcome to this Marriott International second-quarter 2006 earnings conference call.

Today's call is being recorded.

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

Mr. Sorenson, please begin.

Thank you, Cynthia.

Good morning everyone.

Welcome to our second-quarter 2006 earnings conference call.

Joining me today are Laura Paugh, Senior Vice President Investor Relations;

Donna Blackman, Senior Director Investor Relations; and Carl Berquist, Executive Vice President Financial Information and Enterprise Risk Management.

Before I get into the discussion of our results, let me remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under federal securities laws.

These statements are subject to numerous risks and uncertainties as described in our SEC filings which could cause future results to differ materially from those expressed in or implied by our comments.

Forward-looking statements in the press release that we issued earlier this morning along with our comments today are effective only today, July 13, 2006 and will not be updated as actual events unfolds.

You can find a reconciliation of non-GAAP financial measures referred to in our remarks at our website at www.marriott.com\investor.

Results from our second quarter were simply outstanding.

Earnings per share totaled $0.43, up 48% over the prior year.

North American system-wide revenue per available room or REVPAR increased nearly 11%, with room rates alone up 8.9%.

Adjusted EBITDA totaled $363 million, a 19% increase over the prior year.

As an encore to the first quarter, REVPAR was again very strong in the second quarter.

Markets such as Atlanta, Miami, Boston, and Chicago reported REVPAR growth over 15% benefiting from strong city-wide convention demand.

Strong trends in demand drove Los Angeles REVPAR up 16% and Manhattan REVPAR up 13%.

Across the U.S., the mix of our trends in business improved as we continued to reduce available discounts and special rates.

Our limited service brands, Courtyard, Residence Inn, TownePlace Suites, SpringHill Suites, and Fairfield Inns typically located in suburban markets together reported 11% system-wide REVPAR improvement.

Ritz-Carlton increased REVPAR 10.4%.

Group attendance continued to run ahead of meeting planner expectation.

Last-minute guests attending group functions frequently booked at corporate rates.

Groups that arranged their meetings at the last minute are also paying more, as much as 10% above last year.

Food and beverage prices and related revenue were also higher, with F&B revenue up 8% from last year.

We booked more profitable room groups into our hotels as measured by length and pattern of stay, as well as by their consumption of food, beverage, spa, AV, and other services.

Outside North America, system-wide REVPAR increased nearly 11% during the quarter.

Asia continues to be very strong as REVPAR climbed nearly 10% with particular strength in Hong Kong.

Caribbean REVPAR rose 13% and Mexico was up 23%, with 14% higher room rates.

Demand for European destinations was very strong as well, particularly toward the end of the quarter as groups and business trends and travelers visited European cities before and as the World Cup began.

In June and early July, our German hotels were filled with some of the world's most committed sports fans, so third-quarter results should be very strong for the continent, particularly Germany.

As terrific as the REVPAR news was, we are even more excited about how much of that revenue was brought to the bottom line.

Domestic house profit margins climbed 300 basis points and if calculated on an as-owned basis, EBITDA margins of our domestic managed hotels climbed 320 basis points.

Worldwide house profit margins increased 280 basis points.

Utility costs rose only 10% and many hotels locked in prices for the rest of the year, reducing this risk over the near term.

Hourly wages rose approximately 3% but were partially offset by productivity improvements and deficiencies in management staffing levels.

Higher room rates and good cost control accounted for much of the house profit margin improvement, but stronger catering revenue, spa business, and other revenues also drove margins higher.

As a result of those strong margins, house profit per available room rose 18% in the U.S. and U.S. incentive fees rose 61%.

56% of our managed hotels earned incentive management fees in the second quarter, compared to only 42% in the year-ago quarter.

Our flagship Marriott brand contributed $12 million of the IMF improvement, led by very strong performance at downtown and convention hotels.

The Courtyard brand contributed $8 million of the incentive fee improvement in the quarter.

We are seeing the benefit of the Courtyard reinvention and new bedding as well as the impact of strong lodging demand spreading to suburban markets.

Domestic company operated Renaissance REVPAR was up 16% and house profit margins increased 5.5 percentage points.

One key to the performance of this brand has been the ownership changes over the past year.

As new owners renovate Renaissance properties, we are rolling out proven systems that drive efficiencies through such things as labor management systems and centralized accounting.

Looking ahead approximately one-quarter of North American company operated Renaissance hotels will have meeting space renovations underway in the second half of this year, which will slow group bookings somewhat for the balance of the year.

Of course many other hotels throughout our system are also undergoing renovation.

We estimate all owners and franchisees will spend north of $2 billion this year on renovation activity in our system and anticipate similar spending levels over the next few years.

Marriott branded properties are taking a leap forward with new product initiatives that include thin flat panel TVs, granite vanity tops, new lighting packages, and technology features that accommodate travelers carrying not only laptops but digital music players and other personal electronic equipment.

Base and franchise fees increased 13% during the quarter, reflecting higher REVPAR and unit growth over the past twelve months.

Franchise fees in the second quarter also included about $3.5 million of relicensing fees as franchised hotels continue to change hands at record levels.

Owned, leased, corporate housing and other revenue net of direct costs rose 12%.

The improvement was largely due to the Renaissance hotels we purchased last year.

Of course many of these hotels were sold by the end of the second quarter.

The profit improvement was in spite of losing about $5 million of land rent compared to last year.

In addition, last year's other revenue included a $10 million termination payment from the owner of a hotel in conjunction with the termination of our management agreement on that property.

We opened nearly 5000 rooms during the second quarter.

Nearly one-quarter of our openings were outside the U.S., including new build Courtyards in Prague, Venice, and Vienna.

Our development pipeline increased to over 80,000 rooms largely due to Marriott, Renaissance, Courtyard, and Ritz-Carlton additions outside the U.S., as well as a growing number of franchised limited service hotels under development in the U.S.

In owner surveys, preference for Marriott's brands outdistances the next leading competitor by a 13 to 1 margin and it is not just the same people opening new hotels.

In recent years, many properties have been purchased by first-time Marriott owners including minority and women owners.

Including the recent RLJ Development transaction, today 390 of our hotels are owned by minority and/or women owners.

The Ritz-Carlton pipeline increased again in the second quarter as the addition of four hotels took the pipeline to 27 properties under development worldwide.

In total we operate 60 Ritz-Carltons today, so our committed pipeline represents almost 50% system growth.

Owners are finding that Ritz-Carlton is a lifestyle brand that has tremendous value either standing alone or as part of a mixed-use development.

Across all our brands, important projects such as the Orlando Grand Lakes Resort, the new L.A.

Life mixed-use development and the new Boston Seaport Renaissance help and will continue to help drive brand image and move overall room rates higher.

And long-term management agreements, that is those without owner termination on sale provisions, ensure that new hotels are adding real value to the Company.

A number of our principal competitors are buying management contracts with shorter terms or with termination on sale provisions that create real doubt about their long-term involvement in those hotels.

We remain focused on adding hotels to our system with contracts that ensure long-term affiliation with our brands.

It is better for our customers and associates and of course there's more long-term value for our shareholders.

Today international development makes up one-quarter of our development pipeline and over half of our full-service development.

In fact this is such an important part of our growth strategy that we have decided to hold our 2006 Company-sponsored security analyst meeting in Paris, where investors can see firsthand the progress we have made in driving value in an important global destination.

You will also be able to see our new European prototype Courtyard hotel scheduled to open in a Paris suburb in August.

The analyst meeting is scheduled for October 19 with property tours available both on the 19th and on Friday, October 20th.

For the second quarter, time-share interval, fractional, and whole ownership sales and services revenue was roughly flat year-over-year but contracts sales, the best indicator of current performance, increased 40% in the quarter largely due to strong demand at our Sequel Vacation Club in Maui and our new Ritz-Carlton projects in San Francisco and Hawaii.

The Ritz-Carlton Club and residences in San Francisco is located in the former Chronicle Building at 690 Market Street.

This historic building is undergoing a $90 million renovation and will offer 49 fractional and 52 private ownership residences opening in November 2007.

While fractional demand is strong, whole ownership demand has been phenomenal.

We have been in sales about four weeks and have already signed contracts for 95% of the whole ownership units.

Many of the new fractional and whole ownership projects in 2006 are joint ventures.

These projects are likely to become financially reportable in 18 to 24 months and when they are reported, the profits will be reflected on the joint venture line labeled equity in earnings on the P&L.

Of course our time-share segment results capture all of the profits from the time-share business regardless of the source.

Our Synthetic Fuel business contributed approximately $0.01 to earnings per share in the second quarter.

We stopped producing Synthetic Fuel at all four plants in April.

A decline in earnings was due to much slower production of Synthetic Fuel combined with an assumed 38% phaseout of the tax credits generated so far in 2006.

The tax credits are gradually phased out as oil prices rise over a benchmark level.

With the recent spike in oil prices we can't be certain when or whether we will turn the machines back on.

As you know, Synthetic Fuel tax credits cannot be earned beyond 2007 in any event.

We continue to exclude this business from our earnings guidance.

General and administrative costs declined 50% from the 2005 quarter.

We talked last year about the noncomparable items in last year's quarter, which totaled $141 million.

G&A expenses in the 2006 quarter included $9 million of costs for the new rules pertaining to expensing share-based compensation offset by a $4 million favorable impact from the reversal of a guarantee reserve, $2 million of foreign exchange gains, and $6 million of lower deferred compensation expense.

Gains and other income totaled $48 million during the quarter, compared to $63 million in the 2005 quarter.

We sold seven hotels and interests in four joint ventures for roughly $555 million combined.

We also sold $242 million in time-share notes in the quarter for a $40 million gain on that transaction alone.

These gains were partially offset by a $37 million non-cash charge to adjust the carrying amount of a straight line rent receivable associated with a land lease.

The land lease is subject to a purchase option that is likely to be exercised.

Recently the time-share industry has been communicating with the SEC regarding the appropriate presentation for time-share note sale gains.

While our second quarter P&L includes time-share note sale gains in the gains and other income line, the time-share industry is proposing that we instead include time-share note sale gains and operating income.

This proposal is consistent with the time-share SOP, that is the new accounting rules for the time-share industry.

ARDA, the American Resort Development Association, represents the industry in this matter.

If such a change occurs prior to the filing of our second quarter 10-Q, which we expect to file shortly, the Q will reflect the new presentation.

Of course there would be no impact from this change in geography on net income.

Let me take a moment to compare our overall second-quarter results with the guidance we provided back in April.

Excluding our Synthetic Fuel business, second quarter EPS guidance was $0.38 to $0.40, adjusting for the impact of the 2-for-1 stock split that was completed in the quarter.

Actual EPS excluding our Synthetic Fuel business was $0.42.

In other words, our earnings were $0.03 better than the midpoint of our guidance or $0.06 better on a pre-stock split basis.

On the fee line, our managed hotels earned $0.02 more than expected in higher incentive fees due to strong REVPAR and fabulous margins.

Owned hotel results were better-than-expected by about $0.01 due to both strong operating results and because asset sales occurred later in the quarter.

G&A was lower than expected by about $0.02 due to lower-than-expected deferred compensation expense, a reversal of the guarantee reserve, and better-than-expected foreign exchange gains.

We had an offset to the good news in deferred compensation.

The tax impact from deferred compensation increased our tax rate to 35.9% yielding about $0.01 unfavorable performance on the tax line.

On an ongoing basis, we expect our tax rate should run at about 34.9%.

Finally we give about $0.01 back in higher net interest expense driven by higher rates and higher debt balances than we had modeled.

Overall our results reflect the continued strong business environment for lodging.

With the excellent progress on asset sales and very strong cash flow from operations, during the quarter we bought back 10.5 million shares of stock for $380 million and in the third quarter through today, we have purchased roughly another 3 million shares.

So year-to-date we have purchased nearly 21 million shares.

Now let's turn to our outlook for Q3 and the full year.

In the third quarter, we expect North American company-operated hotel REVPAR to increase 8% to 10%.

Reflecting the stronger performance in the first half, we expect full-year 2006 REVPAR to increase 9% to 11%.

We expect property level house profit margins to increase 225 to 275 basis points in both the third quarter and the full year.

With REVPAR growth, margin improvement, and unit expansions in 2006, we expect reported management and franchise fees for the full year to increase roughly 16% to 18% to $1.19 billion to $1.21 billion.

In the third quarter of 2006, we expect total fee revenue to increase to $250 million to $255 million.

We estimate owned and leased earnings should total approximately $35 million in the third quarter.

The $4 million decline from the prior year is largely due to the successful sale of hotels which we continue to manage.

We expect owned and leased earnings to total approximately $170 million for the full year 2006.

Turning to the time-share business, in the third quarter we expect contract sales to continue very strong.

Two new projects will start sales in the third quarter.

As we mentioned on our last call, since financially reportable results lag contract sales, our flattish contract sales pace in 2005 implies soft reported profits for the 2006 full year.

But the strong contract sales growth today is positive for future periods.

One thing to keep in mind though is that the lag between a contract sale and book recognition of profit is significantly longer for whole ownership residential than it is for time-share.

We anticipate that time-share, interval, fractional, and whole ownership sales and services revenue net of direct expenses should total approximately $65 million in the third quarter and $250 million for the full year.

This forecast is a bit more modest than last quarter, reflecting some delays in project starts.

We expect general and administrative and other costs will decline from $753 million in 2005 to a range of $650 million to $660 million for the full year 2006.

Estimated G&A includes roughly $37 million in non-cash costs associated with FAS 123(R), the new accounting rule for share-based compensation.

Third quarter G&A is expected to total $155 million, including approximately $9 million in pretax FAS 123(R) impact.

We have had considerable success recycling capital this year.

Year-to-date we have completed $1 billion in the note collection (technical difficulty)

One moment sir.

Please go ahead.

Thank you.

Year-to-date we have completed $1 billion in note collections and real estate, joint venture and note sales including our time-share note sale in the second quarter.

For the full year, we expect proceeds to total $1.5 billion including proceeds from time-share mortgage note sales.

On the P&L, gains and other income excluding Synthetic Fuel have totaled $83 million year-to-date.

With little real estate remaining to sell, we expect gains and other income to total only about $10 million in the third quarter and approximately $130 million for the full year.

Equity and earnings is expected to total approximately $10 million to $15 million in 2006, a decline from 2005 reflecting the sale of several joint venture hotels in 2005 and early 2006.

Results have also been constrained by start-up costs associated with our time-share joint ventures.

Given these assumptions and those outlined in the press release, we believe earnings per share for the full year 2006 will likely total between $1.52 and $1.57 per share or about $0.03 more than our last forecast, primarily reflecting the strong performance of the second quarter.

This forecast excludes the one-time non-cash impact of accounting changes for the time-share business, which we reported in the first quarter and ignores altogether our Synthetic Fuel business.

So how do we bridge our new 2006 full-year guidance from our last forecast?

First of all, our full-year 2006 guidance for fee revenue has increased by about $0.03 per share, reflecting strong performance in the second quarter and expectations of higher incentive fees for the rest of the year.

Owned, leased, corporate housing, and other net of direct expenses increased by about $0.02 to $0.02 largely due to strong performance from our owned hotels in the first half.

Many of those properties are now sold.

Time-share, interval, fractional, and whole ownership sales and services net of direct expenses declined about $0.01 from our prior guidance, reflecting modest delays in construction pace.

Our guidance for general administrative and other expenses improved by about $0.01 to $0.02 versus our last forecast due to the performance of the second quarter.

And we did a bit of fine-tuning to our interest expense, equity and earnings, and tax rate forecasts, which combined cost us $0.01 to $0.02.

Net-net, we end up about $0.03 higher than our prior forecast.

Some of you are likely to characterize our updated 2006 guidance as just more of Marriott's conservative approach as we added the upside of Q2 to our prior guidance and appear to have left the balance of the year numbers essentially unchanged.

You may believe that the upside potential in Q3 and Q4 must be comparable to that of Q2.

While we always strive to do better, after all success is never final, we would encourage you to take the balance of the year guidance seriously.

With 8% to 10% REVPAR growth and 225 to 275 basis point margin improvement already baked into our model, and with the bulk of our asset sales already completed, there are few significant drivers for additional near-term upside performance.

As we look forward to the rest of 2006 and on into 2007, we have rarely been more bullish about our business.

We have few forward-looking data points around transient demand.

Marriott brand group revenue on the books for the second half of 2006 is already up 10%.

For 2007, group revenue already on the books is up over 8% over 2006 levels this time last year.

Today our large convention and resort full-service hotels are paying substantially higher incentive fees.

Many newer hotels are paying incentive fees for the first time.

Our limited service hotels have also recovered nicely due to both strong travel demand as well as the product improvements of the past few years and they are also generating significant incentive fees.

So do we see any signs of weakness?

It is probably the most frequent investor question we hear these recent days.

Certainly some markets are stronger than others.

Demand in Washington, D.C. has been soft this year with fewer city-wide conventions.

The lobbying scandals have probably reduced the number of three-martini lunches in the nation's capital at least temporarily.

In the last four or five weeks we have also seen some softening in travel demand in Southern California both in lodging and time-share, however this trend seems to be a local market matter.

Third-quarter bookings in Florida and the Caribbean are soft, reflecting meeting planner concerns about another active hurricane season.

But the meetings are still going on, either at inland properties in the third quarter or in Florida in the fourth quarter.

But these are the only signs of softness we can find in our business and they are overwhelmed by the signs of strength.

Strong demand growth, pricing power, and real profit flowthrough.

We have the right business model.

We have the best brands, and we have the finest associates delivering the best service in the business.

We have already demonstrated the staying power of our Company, but we are a long way from being done yet.

Cynthia, we would be pleased to take any questions.

(OPERATOR INSTRUCTIONS) Steve Kent, Goldman Sachs.

Just maybe you could talk a little bit about the pipeline development, especially the domestic and the international.

I guess I always struggle with a low supply environment yet your pipeline and others keep on increasing.

Then you did mention you had quite a few new builds and conversions, but maybe you could talk a little bit more about that.

Then finally, Arne, in the beginning of your comments you said that there were some basically what we would characterize as mix changes, more higher paying group businesses and maybe some groups that booked maybe a year or two ago at lower rates are disappearing.

How long does that go on for?

Do you still have a pipeline of what we would characterize as relatively low group rates right now?

That's a lot, Steve.

Let's start with the pipeline.

The increase to about 80,000 rooms, a bit over 80,000 rooms, that we report this quarter obviously is a global number.

It is driven by the two kinds of products we referred to in the prepared remarks, predominantly full-service and full-service like hotels in international markets and limited service hotels in the United States.

Limited service hotels in the United States are obviously Courtyard, Residence Inn, SpringHill Suites, TownePlace Suites, and Fairfield Inn.

Those brands are all generally doing extremely well both from a REVPAR perspective and from a perspective of attractiveness to the franchise and owner community.

Courtyard and Residence Inn are category killers with nearly 30% REVPAR premiums in both of those brands compared to their competitive sets.

And as our partners look around at development potential, they see those as good propositions.

That is where most of the growth in the pipeline is coming from in the United States.

So from a supply perspective I think when people talk about low supply growth, it is most frequently a comment about the U.S. market, not global market.

It is most frequently a comment given in relationship to the public companies, listed companies in our space, most of which are dominant full-service and urban product or established resort destinations and we are seeing very little supply growth in those kinds of markets.

You talk about the rest of the world, China and India are obviously both big markets from a population perspective.

India is a tiny market from a hotel perspective at present.

We think there are fewer hotel rooms total in India today than there are in the city of Orlando, Florida, just to give you a reference point.

China is a significantly bigger hotel market than India, but certainly is a smaller market and you would expect given its population and its potential.

But we have I think open today 12,000 rooms in China, 31 hotels.

We probably have about half that many rooms under construction or essentially definitized deals, another 6000 rooms and we've got probably another 6000 rooms behind that which are not yet being counted in our pipeline but which are real specific deals which are being worked on by our developers.

That is probably the highest percentage growth market that we have got out there and obviously has nothing to do with the supply/demand dynamic or very little to do with the supply/demand dynamic in the United States.

Then your last question was mix shift, how long can that go?

I think that can go for a sustained period of time.

We are really just starting to see that.

If you look at REVPAR, sort of a run rate REVPAR and compare it to 2000 peak level REVPAR performance, what you see is rates now consistently above in nominal terms the rates that we were charging in 2000, but occupancy is still a few points shy, probably 3 or 4 points shy of where they were in 2000.

We have not seen much occupancy growth, but we have seen a little.

As we continue to see occupancy grow particularly midweek occupancy, we will continue to see ability to mix business towards higher rated and less discounted and less promotional sorts of packages than we've seen in the past.

That ought to be a year's long trend.

Okay, thanks.

Felicia Hendrick, Lehman Brothers.

I just wanted to ask you a question on your time-share business quickly.

You definitely continue to post impressive results and obviously also anticipate those.

And also I know if you just look at the time-share business since the '90s, it has grown every year.

That said, with economic data pointing to a slowing consumer, I am just wondering how you can maintain your confidence in the continued growth of this business?

What are you seeing maybe versus what the market is perceiving?

Then just on your capital recycling program, you've pretty much completed what you stated you would do this year.

I was wondering if there would be any kind of update to that going forward?

Okay, time-share, let's start with that.

We ask exactly the same questions that you have just asked all the time when we're looking at our time-share data.

We have got a few reasons I think to -- obviously we can see the data but we have also got a lot of history in this business.

We entered the time-share business 22 years ago, 23 years ago, if I'm accurate about that.

We have been through lots of cycles.

Weak consumers, high interest rate, weak economic growth.

We have seen just about everything and our experience is that this business performs pretty well through every stage of the cycle.

Why?

Not exactly clear, but I think the biggest reason is that time-share, the core time-share product is a vacation alternative that increasingly over time even when consumers are relatively more strapped, the family vacation and these are by and large family products, at least the core time-share product, is a necessity.

So those purchases happen it appears through every stage of the cycle.

We are obviously watching real-time the pace on the resorts where we have got product for sale and generally with the exception of the Southern California comment which you heard in the prepared remarks, we are not seeing any signs of a consumer slowdown here at all.

We've talked about this before but it is important to keep in mind that the fractional and whole ownership product which is often included in our time-share business although is a relatively small percentage of our profits today is probably less like a vacation alternative and more like a second home alternative.

We do have weak residential markets out there in many places and we are watching that very carefully.

What we have seen so far though gives us a lot of comfort that the whole residential product or fractional product that we are selling typically is being sold in irreplaceable locations.

So it is product which is very different from the run of the mill North American residential market, which is overwhelmingly suburban and big development focused, less unique from a location perspective than being on the beach in Kapalua or being downtown in San Francisco or being on the slope in Tahoe.

Those places seem to be holding up quite well.

You --?

Capital recycling.

Capital recycling, not much update to give you there other than the prepared remarks.

We have almost gotten to the point where we have sold everything that is not bolted down.

So there's not -- we can't come out at this point and increase the number significantly versus where we were before.

The $1.5 billion figure we gave in our prepared remarks includes both the second and fourth quarter time-share note sale numbers and is essentially with that the same number that we have given you before as a full-year forecast.

The other stuff other than the fourth quarter time-share note sale by and large we have closed just about everything.

There may be $100 million to $200 million of asset sales that we would anticipate over the balance of the year, but nothing terribly dramatic.

Okay, that's perfect.

That answers both questions.

Thank you.

Joseph Greff, Bear Stearns.

By then end of this year, Arne, where will domestic house profit margins be in relation to peak 2000 levels?

Good question.

Let me give you a couple of statistics from the second quarter which I think are interesting.

The Marriott brand when we look at GOP margins, and again that is the margin we use to report to our owners -- I'm talking about managed hotels here -- it is before insurance.

It is before FF&E reserve.

It is before management fees, so it is going to be a little bit different from the numbers that the hotel owners report.

That is the number which was up 300 basis points in the quarter versus last year.

When you look at just the Marriott brand, the number for the brand in the aggregate that we scored in the second quarter is only 80 basis points shy of the number for the brand in its entirety in the second quarter of 2000.

But let me give you one more number because I think to some extent that can be a little bit misleading.

If we back out all of the hotels in 2006 that didn't exist in 2000 in our managed universe, and so we look at not just stabilized or comp hotels but we look at the identical portfolio of hotels, we are about 140 basis points south of peak profit margins in the second quarter.

I cannot tell you off the top of my head what 225 to 275 in Q3 and Q4 mean versus 2000, but I would guess that they are going to be around the 100 to 150 basis point range south of 2000 peak levels when you look at a true comp set -- which should bode fairly well for the odds of hitting peak margins in 2007.

And of course those aren't peak margins going forward.

There is still considerable upside to improve beyond those peak margins in the years after 2007.

Was there one or two drivers in the second quarter that caused the strong margin performance?

I think there are three that are really important.

The rate growth is singularly the most significant with the kind of ADR we had in the U.S. building on last year's tremendously strong ADR growth, we're just finding a lot of that can fall to the bottom line.

That is probably one-third, maybe a heavy one-third of the total margin improvement.

Nearly one-third probably comes from other revenue, F&B growth and F&B profitability as well as spas and other revenue in the hotel.

And probably nearly one-third comes from the great work that our operating team is doing around cost efficiencies.

And that is both in the hotels and it is in programs that are above the hotels which we are squeezing additional efficiencies out of.

Okay, great.

And then, Laura, do you have what the share count, the diluted share count was at the end of the second quarter?

We'll look it up here for you and we'll come back to in a minute.

Great.

That's all.

Thanks, guys.

Harry Curtis, JPMorgan.

Good morning.

Two quick questions.

Arne, you discussed the timing of contract sales moving into recognized income.

Is there some period in 2007 where that is likely to accelerate?

I think I made the comment in the prepared remarks about whole residential and you take San Francisco as an example, which we talked about in our comments.

We will sell -- enter into binding contracts with significant deposits on 100% of the whole residential in the San Francisco, the Ritz-Carlton development we have during 2006.

Probably maybe entirely within the third quarter of 2006 it is going so well.

But those sales will not close until 2008 and as a consequence, the profits associated with those sales which will come through the joint venture line, will stretch out and won't be finally achieved in their entirety until 2008.

That is just one example.

We've got a big project in Kapalua, another Ritz-Carlton project, which has fractional whole ownership as well.

That sale has just begun in the last 30 days or so, maybe 60 days, something like that.

Going very, very well but that is going to have sort of a similar sort of schedule.

Long-winded way of saying I think we will start to see the more powerful ramp up in quarter-to-quarter book profits later in '07 but hopefully sometime in '07 and certainly strongly into '08.

That's helpful.

And then the second question is you mentioned your strong pipeline of Ritz-Carltons.

Do you have a sense of what share of the pipeline in the luxury segment you have got?

To answer that I think we would really need global data and I don't think we have got very good data on that.

We know it is a very prominent share.

We think Ritz-Carlton is far and away the most proven luxury brand for mixed-use development.

We have obviously got some stellar competitors out there in the luxury hotel business.

We think Ritz-Carlton has gone much farther and faster and proven in branded residential and fractional product and most of the resort development today cannot be done without mixed-use.

So we think we're getting a good look at many, perhaps most of the mixed-use development projects around the globe.

Why the success do you think?

I think we have just done more of it.

Ritz-Carlton obviously is a great brand, but we have also done more of it, probably started sooner with it.

You look at the Ritz-Carlton projects in domestic U.S., in Boston and New York and in Washington all with Millennium Properties; it has been a great partnership.

Every one of those was done with the residential piece to it.

I think another element to Ritz-Carlton development has been the advantages I think we have brought in terms of the cost side, having Ritz-Carlton enjoying the benefits of being part of the Marriott system in terms of the back of the house systems where the customer does not see it but it certainly improves profitability for owners.

Then on average also if you look at the quality of the pipeline, the hotels tend to be a little bit larger than what competitors are developing.

So that also tends to enhance profitability of those properties.

In answer to Joe Greff's question earlier for everyone, the common shares outstanding at the end of the quarter were 406 million.

Of course that excludes the dilution factors that are included in the fully diluted shares of about 24 million shares.

I'm all set.

Thank you.

William Truelove, UBS.

All our questions have been answered.

Jay Cogan, Banc of America Securities.

I have got a house out here if you guys want to sell that too.

Just let me know.

I have got question for you regards to the capital recycling I guess kind of expanding on what you've already said.

Before you said that $1 billion in sales ex the time-share notes gets you probably about $1 billion in buyback.

You’re obviously making good progress on that.

I was wondering if there is any thoughts just given your relatively low leverage of maybe expanding the buyback a bit?

Or can you give us some sense as to what you are waiting for right now in terms of keeping the flexibility on the balance sheet as significant as it is?

Good question.

Obviously a lot of conversation around this issue.

I think probably it is mostly a good thing, but as we look back over the last few quarters I think we almost always conclude internally here we wish we had bought back even more stock even though we have purchased, what? -- 1.650 billion last year and about 740 year-to-date this year.

Help me do the math here; that sounds like 2.4 billion roughly of share repurchases in the last six quarters.

If we had sat -- if you had heard us talk internally 1/1/'05 in the privacy of our conference rooms here, you would not have heard any of us say that we thought we could buy back $2.4 billion and have our debt levels really not move from where they were at that point in time.

That is what we've seen.

So in hindsight maybe it would have been great to buy back more during those periods.

Why didn't we?

Obviously we have recycled an awful lot of capital and it has come in faster and in bigger numbers than we anticipated materially so and right up through the second quarter of 2006, it has proven that to us.

I think as we have looked at it more you can see we stepped up our pace in the second quarter meaningfully over first quarter.

I think you should expect that that pace will continue through the balance of 2006.

So we will see a full-year number of share repurchases in 2006 as a working assumption more like the 2005 number than the number we talked about a quarter ago, which was more like $1.2 billion or so.

We're probably thinking now more like $1.5 billion or $1.6 billion.

And I suspect we will continue to be aggressive buyers of our stock not just as those numbers suggest over the balance of this year, but going forward assuming we continue to have capacity that is not used on our balance sheet and can't be put to work to make value in growing our business, which is obviously our priority.

Then in regards to just -- you had commented on where you had been seeing some weakness but just maybe to expand a little bit on some of the recent data that has been coming out from Smith Travel where Friday and Saturday nights have been kind of unusually modest in terms of their gains.

Your guidance is what it is, so I guess we're projecting some improvements through the balance of this summer, or is it really going to be just that midweek is going to be that strong and it'll make up for any so-so leisure comps?

Can you just give us a little bit better sense as jewelry should be looking for going forward?

Yes, you've Smith Travel data out there.

The last few weeks I think are a little squirrelly given the timing of the July 4 holiday and as a consequence, we don't put that much stock in what we have heard over the last few weeks.

The REVPAR numbers obviously last week for the week as a whole were flattish versus last year based on the Smith Travel data.

July 4 was Tuesday this year instead of Monday last year.

We think that has had probably a more significant impact just on travel patterns during the week and perhaps on the weekends as well.

When we look at the second quarter data and look at weekend occupancy, weekend occupancy actually grew more year-over-year than weekday occupancy grew.

And so as a consequence, we will watch this carefully.

It almost goes without saying but we should repeat ourselves just to make sure everybody knows it.

Leisure is important to us particularly as it relates to the time-share business.

As it relates to the hotel business, is roughly only 20% of our volume of business in the hotels.

From a rooms revenue perspective, it is less significant than that from a total revenue perspective and from profit perspective.

Just as a really last question, understanding that you don't have that many unionized hotels but knowing how negotiations will affect I guess your wages and benefits of all of that at your hotels to remain competitive in those markets, can you give us some sense as to how you think things are going?

Obviously there is a lot of work still to be done but just your sense of the progress made thus far and where wage and benefit and inflation is coming out or could come out?

I think is going more within the range of what our expectations were internally, which are that these issues can be resolved in most markets if there are parties that want to resolve them if the economic issues are not enormous.

And what we saw in New York was more or less within what we expected to see.

If anything, it's probably on balance a bit of a good sign that both parties to those negotiations seem to want to get something done and got something done and if that carries over, the other markets will get resolved as well.

Great.

Thanks a lot.

Jeff Randall, A.G. Edwards.

Arne, I know people have kind of beat up the Ritz-Carlton thing, but if you could just comment a little bit more on the pipeline and how robust is the developer interest beyond what's sort of formally included in that pipeline?

And then secondly, you said there's a lot of mixed-use but I don't know if you said mixed-use urban, mixed-use resort?

I wondered if you could clarify that?

Then sort of what is the domestic/international split in the formal pipeline?

Let see.

Start with the middle question.

Mixed-use is mostly resort but as you can tell from the example we used in San Francisco, there is at least some urban.

Urban tends to be whole residential projects a bit more than fractional projects but mostly we're talking about resort destinations.

I guess to go to your first question, we are talking about a number of mixed-use Ritz-Carlton resort markets in mostly beach locations, mostly North America or near North America, so include the Caribbean or the entire Gulf Basin if you will.

We are talking about a number of resorts that are not in our pipeline.

They will not all happen.

They probably should not all happen but we have got very excited developers that are looking at projects that are not yet in our pipeline.

So I'm sure there is potential to add additional units to our pipeline that are not in it already.

International piece you know when you get away from the mixed-use, Ritz-Carlton is in very high demand globally.

Probably 60% of the total number of hotels that we talked about are outside the United States.

That does include a handful maybe in the Caribbean, but the balance would be farther away than the Caribbean.

I talked about China a few minutes ago.

In China alone we have six Ritz-Carlton hotels under construction.

Okay, great.

Another question.

You mentioned softness in Southern California.

I just wondered if you could talk about maybe what you attribute that to?

I am not sure we have the material in front of us to be very expert on what is happening in Southern California, but when we look around the weakness appears only in hotels or time-share product which appears to be primarily drive-to from Southern California.

And it is that which really gives us the view that this is fundamentally a local issue.

But it has also only been in the last five or six weeks, so it's very recent.

Okay, great.

Thank you.

Michael Millman, Soleil Securities.

A couple questions.

I think you touched on them but on occupancy, the revenues seems to be driven by rather low increases in occupancy and those low levels of occupancy seem to be matched by the pipeline.

So maybe you can talk about what this might suggest about revenue growth going forward if indeed the pipeline covers the occupancy gain?

Sort of related, could you talk a little bit about price elasticity and maybe price elasticity by segment and also by traveler type?

Thank you.

Yes, those are good questions.

The occupancy has grown much more modestly than rates relative to the depths of performance in 2003 or relative to the peaks of performance in 2000, either way you look at it.

That is overwhelmingly a good thing.

It is a good thing from a perspective of profitability of the hotels and it is a good thing from the perspective of the upside potential which I think remains in the business.

The supply growth I think has undoubtedly -- it has something to do with it in a macroeconomic sense, but I don't think it is a very powerful explanation of the modest occupancy growth.

In fact the supply growth has been so low 2004, 2005, and even now 2006 and is likely to stay meaningfully lower certainly as you look at full-service product, meaningfully lower than demand growth based on I think all the economists that are out there over the next few years.

All of which is a long-winded way of saying I think there's more occupancy potential ahead of us than any other aspect of occupancy you should think about.

Price elasticity, a fancy term, maybe too fancy for me.

The pricing power we think that we are experiencing today from a macroeconomic perspective is to us driven by the obvious, which is demand is growing a lot faster than supply is growing.

With the help of our folks in revenue management who are really all about using the data, both the current data from our system and from our customer interactions with us as well as some historical data forecasting trends are doing a great job helping us yield the business that is available for our hotels and shift higher rated business into the hotels.

And price in the segments where there is more pricing power.

Probably not surprisingly the best pricing power is in with the business trends in traveler, who has got the least options.

They tend to book relatively late versus their stay, within ten days usually of their trip and in many markets, the cities we talked about, midweek, these cities are nearly full and it gives us -- I think gives the industry a good ability to price.

Historically folks would have looked at leisure and said there's much less pricing power in leisure and I think that is still generally true, but in the key resort destinations, leisure customers are paying significantly more than they have paid in the past and they give every indication that they are enthusiastic at least in terms of the size of that demand about paying those rates.

And we are seeing more pricing power in those segments as well.

Particularly in the luxury tier.

Particularly luxury and the sort of higher end full-service.

In talking about pricing leverage, is a business transient likely to turn to the next hotel down the block because it is $10 cheaper?

Well, probably only if their company tells them they have to.

As often as not you are seeing a more significant problem, which is that they call too late, they find the hotel that they want to stay in is full.

And that is the problem when you don't have a lot of hotel construction in downtown markets when people want to go to downtown markets and stay someplace close to their destination, it is hard to find that hotel.

Okay.

Cynthia, we will take one more question before we thank everybody for their time this morning if there is still one in the queue.

Joe Fath, T. Rowe Price.

Just real quick two quick questions on incentive fees, Arne.

When you look at the hotels that are in the system in '06 that were also in the system in the peak in 2000, what percentage of those are paying incentive fees now?

Of the ones that have incentive fee components in their contracts.

I don't know.

We will have to get it for you, Joe.

Second one then, also the contracts that are not paying incentive fees yet, if you had to bucket them, how close are they to being in the money?

We will -- we have used some of that bucketing before.

We will use it again at the analyst conference in October.

There are a big number of hotels that have obviously just crossed into incentive fee land. (multiple speakers) So you look at the statistics this year versus last year and you're talking about a lot of hotels that have moved.

The only point I think I'd make about incentive fees, we gave in the prepared remarks, not in the press release not just the growth rate of incentive fees in the aggregate for us globally, 48%, but the growth rate in the United States.

And you can see that growth rate was significantly higher than the global growth rate for us.

What is happening behind the aggregate numbers for us and has over the last few years, we went from a bit over $300 million to about $100 million at the low point.

I thing most consensus forecasts have us around 250 or so for full-year 2006 now.

So coming a long way back.

But during that period of time it was the U.S. incentive fees that were hit the hardest so even though the aggregate number fell mightily, the U.S. number fell even more and we are seeing that U.S. number come back at a faster pace today than we saw before.

That means we are already above peak levels in dollar terms for non-U.S. sources of incentive fees, which over the medium-term gives us great confidence we will not only get back to peak incentive fees, incentive fees in dollar terms, but we'll get beyond that.

Good color, thanks.

All right, we thank you all very much for your time and attention this morning.

I look forward to seeing you in our hotels and the opportunity to check you in and greet you with a smile.

Ladies and gentlemen, this will conclude today's conference call.

We do thank you for your participation and you may disconnect at this time.