萬豪國際 (MAR) 2009 Q2 法說會逐字稿

Good day, and welcome to the Marriott International second quarter 2009 earnings conference call.

Today's call is being recorded.

At this time, for opening remarks and introductions, I'd like to turn the call over to to the President and Chief Operating Officer, Mr.

Arne Sorenson.

Please go ahead, sir.

Thank you, Karen.

Good morning, everyone.

Welcome to our second quarter 2009 earnings conference call.

Joining me again today to discuss the quarter are Carl Berquist, our Executive Vice President and Chief Financial Officer; Laura Paugh, our Senior Vice President, Investor Relations; and Betsy Dahm, Senior Director of Investor Relations.

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

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

Forward-looking statements in the press release that we issued earlier this morning, along with our comments today are effective only today, July 16, 2009, and will not be updated as actual events unfold.

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

We were pleased with our results in the second quarter.

North American REVPAR came in a bit better than our guidance and adjusted earnings per share was at the high end of our expectations.

In North American lodging, we continue to see signs of stabilization in occupancy levels.

It's still too soon to say that we're seeing green shoots but to take the analogy a bit further at least we have some evidence that the planting season is not too far off.

Unfortunately we aren't yet seeing more corporate travelers and business meetings returning to our hotels.

Instead, our mix of business remains skewed toward price sensitive leisure travelers.

For the Marriott brand, room nights sold to corporate travelers, defined as those paying corporate or above rates, declined 18% year-over-year in the second quarter.

In contrast, leisure room nights in the Marriott brand increased 12% in the second quarter, and on the group side room nights from weddings, sports teams, family reunions and the like rose 7%.

Marriott hotels and resorts weekend occupancy was actually higher than weekday occupancy, a very surprising statistic in the peak spring business travel season.

Our sales and marketing teams have done a terrific job driving the demand that is out there into our hotels.

However, with occupancy levels stabilizing in the low to mid 60s, pricing has become a greater challenge.

Everyone is price sensitive today, not just vacationers.

We expect pricing power to return only as occupancy recovers.

For now with rates declining, we are seeing customers increasingly recognizing the great values available and starting with leisure customers jumping at them.

We expect business transient and group customers to follow as they see both the need to get back to work and the tremendous values available today.

Outside North America, we are starting to see more significant REVPAR declines with the economic downturn affecting most markets.

In addition, the H1N1 virus is having a profound impact on our 17 hotels in Mexico and in some markets in Asia.

Political uncertainty has also dampened demand in several countries.

Obviously, the environment for lodging is challenging worldwide.

Still there is much that we can do.

Our lodging marketing teams continue to roll out new programs to gain market share.

Our sales organization is focused on closing business, and our properties are aggressively controlling costs.

For the timeshare business, we rolled out a 25th anniversary marketing program in the second quarter.

We offered discounts on our Marriott Vacation Club product for a limited time, 15% discounts for new owners and 25% discounts for existing owners.

Of the 4,500 buyers who took advantage of our offer, more than half were existing owners buying another week.

We were delighted with the results of the program.

Adjusted contract sales totaled $212 million during the quarter, roughly $55 million more than we sold in the first quarter.

Given the success of the timeshare discount plan in the second quarter, we may consider becoming more aggressive on timeshare, fractional, or residential pricing in the future.

If so, pricing changes could have a material impact on the carrying value of certain projects in our inventory which could result in impairment or other non-cash charges.

Our priority is to drive cash flow in this business.

Companywide, our general and administrative expenses declined over 20% in the second quarter and we intend to keep those costs in check.

We continue to aggressively manage our balance sheet and we are committed to our investment grade credit rating.

With $1.4 billion available under our bank revolver we have excellent liquidity.

Year-to-date, net debt is down nearly $240 million, and we expect it to decline $600 million to $650 million for the full year 2009.

Through continued reductions in our investment spending and substantial cash flow from our fee-based model, we expect to be able to continue to reduce debt in 2010, improving our leverage ratios further.

We have no meaningful debt maturities until 2012 when our revolver matures, but we expect our revolver balance to be minimal at that time.

For our owners and franchisees we remain focused on property level cost control and driving the top line.

We have eased brand standards where it makes sense and deferred scheduled renovations to help owners.

For franchisees, we are communicating more than ever, focusing our advice and assistance on revenue generation, marketing, and cost controls.

We've received considerable favorable feedback from both owners and franchisees.

On the development front, we opened over 8,000 rooms during the quarter and have 110,000 rooms in the pipeline including a new hotel in Hanoi we're announcing in Vietnam tomorrow.

Over half of the hotels in our pipeline are under construction and another 6% are awaiting conversion.

Our lower development pipeline reveals an important truth.

The long-term North American supply outlook has rarely been so favorable.

At the same time our development organization remains successful in signing new deals.

While 4,500 rooms were cancelled from the pipeline in the second quarter, nearly 7,000 rooms were added, largely international deals in Asia and the Middle East, as well as a few limited service hotels in secondary and tertiary markets in the U.S..

As credit markets improve, we expect greater unit growth in the U.S.

will come from conversions.

All of this is possible because of the high value of our brands for owners and franchisees.

We're grateful every day for our business model.

Strong brands, owner and franchisee preference, and guest loyalty, but we recognize the key to our success is our associates.

They have been responsive and creating in dealing with the economic challenges while still taking care of our guests every day and we thank them for their great efforts.

We can't tell you when the economy will recover but we know with mere certainty that the economy will improve, and that when it does, the earnings potential of Marriott will be impressive.

We should see that dynamic play out in an environment where Marriott flags will fly over more than 600,000 hotel and timeshare rooms globally and where demand growth should exceed anemic supply growth by a substantial margin.

Now I'd like to turn it over to Carl to talk about our results for the quarter and our outlook.

Thanks, Arne.

As you saw this morning, we reported adjusted diluted earnings per share from continuing operations for the quarter of $0.23.

Compared to the midpoint of our guidance fee revenue was about $0.01 better largely due to better than expected REVPAR in North America and solid cost controls that drove both [hub] profit margins and incentive fees.

The owned, leased corporate housing and other lines gave us about $0.01 from better than expected house profit margins and better than expected branding fees.

We've picked up about $0.01 from our adjusted timeshare sales and services net line.

In April and May, our stimulus promotion increased contract sales and profits ahead of expectation.

While some of the strong sales were undoubtedly pulled from future periods, we were nevertheless encouraged by the demand of our products.

Unfortunately, our tax line costs us about $0.02, largely due to our 2009 marginal rate moving to 39% compared to about 35.7% in the first quarter.

As the recession has continued to spread around the world our income from low tax rate countries has declined substantially.

The second quarter provision reflects this higher rate.

The changing mix of customers in our lodging business reflects both market realities and our aggressive response to this business climate.

In North America, Marriott hotels and resorts transient customers generated roughly 60% of the brand room nights during the quarter.

Encouragingly, transient room nights declined only 4% in the second quarter as we replaced weak corporate business with leisure, government, and other discounted transient business while the change in mix and price sensitivity drove transient average daily rates down 19%.

In contrast, groups made up about 40% of the brand's customers in the second quarter.

Here, room nights declined 19% reflecting cancellations from months ago, lower participant turnout at meetings, and fewer new group bookings.

While cancellations have subsided in recent months, deteriorating attendance at group meetings commonly referred to as attrition continues to worsen.

All in all, group REVPAR declined 25% during the quarter.

On the upside, we have seen a remarkable improvement in moving tentative group bookings to sign contracts by offering a variety of incentives to our sales staff and meeting planners.

In addition, our revamped sales teams are putting us in front of dramatically more meeting planners.

For transient business, our new weekend promotion during the second quarter yielded record breaking booking activity on Marriott.com.

While room night bookings for the rest of the year are down 18%, today's hesitant meeting planners tell us that they are held back more by the economy rather than the negative rhetoric from Washington.

So when the economy improves we would expect more favorable near-term bookings and stronger occupancy all of which should help transient pricing.

House profit margins in the North American Company-operated hotels declined 5.3 percentage points during the second quarter despite REVPAR declining 23% as our teams continue to control costs.

Labor hours per occupied room have improved nearly 7% and management wages are down 16%.

And as Arne noted, our second quarter showed that the recession is global.

Our international Company-operated REVPAR was off 22% in constant dollars.

The outbreak of the H1N1 flu had a dramatic effect on the results in Mexico.

Occupancies at our 17 hotels there in May were as low as the midteens with REVPAR down 80%.

China and other countries in Asia were also impacted as groups cancelled and bookings slowed due to quarantine concerns, but despite the difficult conditions, have properties around the world operators have done an excellent job in controlling costs.

While REVPAR across our Ritz-Carlton brand in North America was off most significantly, down 31%, Ritz-Carlton's leisure packages were up 59%.

Recognizing that leisure business typically is less affected by the downturn, Ritz-Carlton launched a promotion focused on delivering high perceived value to guests who may be traveling less but still want a vacation to remember.

Let's talk a little bit about timeshare.

Adjusted contract sales totaled $212 million during the quarter exceeding expectations due to our 25th anniversary promotion.

With costs in check, a lot of that upside revenue dropped to the bottom line.

Adjusted timeshare sales and services, net of costs, totaled $16 million.

For a couple quarters now we've discussed the steps we are taking to right size our timeshare business given a weaker demand environment.

We have significantly reduced our investment spending and are committed to our objective of delivering positive cash flow for the business in 2009.

Turning to timeshare financing, the delinquency rate on financed timeshare loans was 10% in June, down a bit from the 10.2% we reported in May.

Given the economic environment, seven timeshare loan pools have hit default triggers year-to-date which as you may recall from our discussions last quarter results in a redirection of cash flow to investors.

We estimate that the net cash flow reduction associated with these triggers will total about $20 million in 2009.

Assuming current delinquency rates and typical receivable aging, we anticipate these triggers will cure in about six months.

As I'm sure you're aware recently released Financial Accounting Standards 166 and 167 will impact the way we account for securitized loans beginning in 2010.

Under the new rules, it's likely we will have to consolidate previously securitized loans.

We are still determining how the new rules will specifically affect the balance sheet and the income statement.

But what we do know is that the underlying economics of the deals will not change and the timeshare loan pools will remain non-recourse to us.

Our revolver covenant calculations do not include non-recourse debt so we don't expect it to change.

Further, based on our discussions with rating agencies, we do not expect any changes in how they look at timeshare securitizations as a result of this accounting change.

For Marriott overall, our adjusted G&A totaled $136 million in the second quarter, down 26% from the prior year.

We are continuing to review our organizational structure, our systems and business processes to improve our efficiency further and right size our overhead as appropriate.

Let's talk about the third quarter.

In the earnings release, we have shared with you a range of top line assumptions that we are using internally to manage our business.

We are sharing these assumptions to help you model the business, but we are not guiding you to any particular earnings number.

Unfortunately, the level of visibility simply remains too low for us to have much confidence in predicting results.

For hotels outside North America, we assume third quarter REVPAR declines 22% to 24%.

International lodging markets have significantly weakened as the economies in many countries have been impacted by the global turndown.

In addition, we've seen significant impact from the H1N1 virus in many markets.

Political unrest in Thailand and the terrorist incident in Mumbai last year continued to reduce travel to those areas.

For hotels in North America, we expect REVPAR to continue the trends seen in the second quarter with REVPAR down 20% to 23%.

Here, much of the REVPAR decline will likely come from lower room rates due to a mix shift to lower rated business and discounting to keep pace with competitors and weaker group business.

Given these assumptions, we assume total fee revenue up $210 million to $220 million in the third quarter.

While unit expansion should help our fees, tougher comparables will likely also impact our results since contingency cost cutting for North America hotels began in the second quarter of 2008.

Given the likely REVPAR decline, margin compression and seasonality of the third quarter, incentive management fees could total zero to $10 million.

With fewer hotels earning incentive fees, the incentive fee impact of resort and convention seasonality is likely to be more pronounced in the third quarter.

We expect owned, leased corporate housing and other revenues net of direct expenses to total approximately zero to $5 million in the third quarter.

While we own or lease 43 hotels, seasonally softer performance combined with the weak economy, particularly in the international market, will continue to constrain profits.

For the timeshare business, while we had good consumer response to our discount plan in the second quarter, we believe it may have accelerated sales that would have occurred later in the year.

As a result, we expect timeshare contract sales to total $165 million to $175 million in the third quarter and timeshare sales and services net of direct costs is expected to total about $15 million in the quarter.

The G&A line reflects savings we've taken at our corporate headquarters throughout our lodging organization as well as in our timeshare business.

We estimate third quarter G&A will decline from $167 million in 2008 to $135 million to $145 million in 2009, a decline of roughly 15% from the prior year.

Quarter-over-quarter comparisons are getting tougher.

Including the benefits from lower interest rates, offset by the impact of a 39% tax rate, we estimate adjusted third quarter EPS at about $.09 to $0.14 per share.

For the full year 2009, we are operating our business assuming REVPAR will decline 17% to 20% on a constant dollar basis for systemwide hotels both inside and outside North America.

Given these REVPAR assumptions, and the more than 30,000 rooms expected to open in 2009, we anticipate our fee revenue could total $1.03 billion to $1.06 billion.

Owned, leased, corporate housing and other revenue net of direct expenses could total $55 million to $60 million.

For our timeshare business, we continue to assume a weak economic climate and adjusted contract sales of approximately $800 million, consistent with our prior outlook.

However, services revenue has weakened a bit as lower room rates have reduced timeshare rental revenue.

In addition, with growing timeshare inventory, maintenance fees from unsold inventory also depresses results as projects are completed.

Further, an $8 million charge for a State tax matter taken in the second quarter will flow through the full year numbers.

In total, adjusted timeshare sales and services revenue net of the direct costs could total approximately $45 million in 2009 and the adjusted timeshare segment results could total roughly $25 million.

We are confident that the timeshare business will have positive cash flow in 2009.

We expect Marriott's hotel investment spending to total about $325 million to $375 million in 2009, a roughly $450 million decline from 2008 spending levels and down slightly from what we expected last quarter.

Compared to 2008 this includes cuts in the net timeshare spending, new capital expenditures and other investing activities.

Compared to the midpoint of our prior 2009 scenario, we reduced total fees by approximately $0.05 per share, largely related to slowing REVPAR in international markets and weaker incentive fees.

Adjusted timeshare sales and services net of direct costs is assumed about $0.02 per share lower due to $0.01 from a State tax reserve I just talked about and $0.01 from lower services income.

The higher tax rate reduces our outlook by about $0.04.

In addition, [below the] line items including higher diluted share count is the result of a higher stock price, cost us about $0.02.

All this implies adjusted 2009 earnings per share of about $0.76 to $0.86 per share.

Despite this very challenging environment, as we look ahead we're optimistic not just because we believe business will come back, but also because we have been strengthening our Company.

We're confident in the future.

As always, keep traveling.

Karen, we'll take questions now.

Thank you.

(Operator Instructions) We'll go first to Jeffrey Donnelly with Wells Fargo.

Good morning, guys.

Good morning, Jeff.

Good morning.

A few questions, Arne, I guess, Arne and Carl, I have to imagine that between the fourth quarter of 2008 and, I guess, I'd say the second quarter of 2009 there's been some significant portion of demand advantage perhaps, I guess I'd say to non-economic reasons.

Whether it's just companies being conservative or fear of attention from politicians or the press, and it may well return in the coming six to nine months similarly for non-economic reasons.

Do you have a sense of where that demand was or sort of where and when it could reappear and how material it could be?

Not really, no.

(laughter) It's an honest answer.

I mean, obviously, you've got enormous economic forces that have had an impact on demand in our industry and demand in virtually every other industry that we can think of.

Those economic forces were further fueled certainly around the financial world and particularly the impact on group and transient travel in the financial business by a toxic political rhetoric which, we think largely is gone.

There may be some few remaining vestiges of that, but by and large you don't hear politicians anymore talking about evils of travel.

In fact, just the reverse, I think you hear increasingly from the White House and from the Hill a due recognition of the significance of this industry to the U.S.

economy and the advantages of travel.

And so I think that is gone.

We are, though, clearly not out of the environment where the economic pressures on our customers have lessened significantly and so as a consequence we wouldn't see that there would be a powerful rebound from the non-economic rhetoric, if you will, until such time as we see the economic forces justify a bit more demand.

It's a good thing they are not scrutinizing my industry.

(laughter) And I'm curious on the cost side.

We had recently done a survey of GMs where, I think about 70% of them said they felt there was really no further ability to reduce costs at the hotel level.

I suspect that view pertains more to non-occupancy related costs.

Do you think that's an accurate view or do you think there's really more that can be done from this point?

This is Carl.

I think, obviously, our folks out in the field have done a tremendous job of managing costs, if you think of how far REVPAR has dropped yet holding margins at 450 basis points down globally.

It's just a tremendous job and I think they continue to look for opportunities.

Now, going forward, obviously, as we discussed about the pricing and how there's a lot of pressure on pricing, it gets harder and harder to maintain those margins because of its rate-driven drops.

In addition, comps get more difficult because we started during the second half of, well, actually, in the second quarter, but more so in the third quarter, cutting costs and controlling costs out in the field.

So I wouldn't give up and say there's nothing there, but it's going to get more difficult going forward but our folks are continually looking at different opportunities.

And just one last question.

Clearly, your organization is hunkering down sort of operationally and, I guess, balance sheet wise, but it also seems like a good time you could be taking share, at least positioning yourself to take share in the future.

Recognizing we aren't probably going to see ramp in new room construction at least here in the U.S., are there areas of your firm that either you're ramping up or not cutting back as dramatically such as a team that would focus on conversions or even maybe asset management areas that can enhance profitability or group or corporate sales teams so that you're well positioned for 2010 and 2011?

Yes, we think in a number of different areas we are, in fact, focused on positioning ourselves for the growth opportunities that are going to be present here soon.

And while we're, obviously, focused on both the balance sheet and managing costs, we're doing that in part so that we have maximum flexibility to seize the opportunities as they come in.

In terms of transactions, we're all reading the same stuff.

We're all hearing the same stories.

I think we know that there is a substantial increase in loans that are either in default or nearing default in our industry.

But there has not been much yet that's traded, and until they start to trade both the opportunities directly to invest in real estate, but also more importantly to us the tradings of assets which drives conversions.

That volume, I think, will stay down a bit.

And so we're ready to pounce, I think you can look across our departments, I think we have cut relatively less in international focused development, for example, because that's still relatively stronger and presents more opportunities.

Not surprisingly we have cut basically nothing at all in terms of the efforts and dollars we spend around work outs and working with our owners and franchisees with troubled hotels.

And, obviously, that will be a substantial industry for the foreseeable future, and in other areas we have tended to cut more but we are very much trying to be set up to seize the opportunities as they come forward.

Thank you, guys.

Thanks, Jeff.

Next we'll go to Janet Brashear with Sanford Bernstein.

Good morning.

I have a question about the rate environment, but I'm wondering if I could follow-up on your last discussion and then at first relative to the margins.

The hotel GMs said they didn't see many more areas where they could cut.

How do you feel about the corporate environment and your operating margins?

Do you see many more areas you can cut?

Well, we continue to look at our business and look at our overhead costs mostly above property as well as the corporate costs.

And as we look out and look at the business we'll continue to right size our overhead and meet the demands of the business.

Obviously, we started the process in the second half of last year so the comps gets a little harder to do that, but we'll continue to look for areas and continue to reduce our costs as the business continues to develop.

Thanks, Carl.

Now if I could switch back to rate for just one second.

The industry trends we're seeing from Smith Travel and others show that in some segments transient rates are falling below the group rates.

I'm wondering if that's true for your brands and if so how do you manage that since then the group rates start to collapse?

There is certainly nearing and I'm sure in some individual instances we've got transient rates that are lower than some of the group rates that are on the books.

And rate is, obviously, the risk here, so when you look at both our results in the quarter and what's implicit in our forecast or guidance assumptions going forward and you look at the industry data, you see the lines crossing at this point.

You see greater relative performance of occupancy so, obviously, down year-over-year.

But looking back over, I think, our last six periods, the rate of decline in occupancy has been flat or improved six straight periods.

You look at rate and I think we're 10 or 11 periods in a row where the pace of decline of rate has accelerated, and that's what we're watching as we go forward.

I think as optimistic and positive as we are about the bottoming of demand, we are concerned about pricing.

Thank you, Arne.

You bet.

Our next question comes from Chris Woronka with Deutsche Bank.

Good morning, guys.

Good morning, Chris.

Curious as to whether you've seen any impact yet from the airline capacity reductions and whether you expect to see any impact in the future?

I know yesterday American announced more cuts, I think, primarily domestically.

Is that something you look at, do you track it, and what kind of impact might there be?

Well, we look at that along with a lot of other indicators to look at -- the indicators out there show who is traveling and the level of travel.

Clearly, the airlines have announced that although they've dropped capacity, they also are having pricing problems in their business.

The planes are full because they've dropped their capacity, but it's what they are getting per passenger mile.

I think one of the things we're seeing is the corporate customer is not traveling and that is the big driver and our people are doing a great job of replacing that business with government and other mix shift types of business, leisure, but as we mentioned earlier, it's a pricing issue relative to that mix shift.

Yes, and is it your view that you can incentivize any additional corporate or group travel with price?

We know you can on leisure, but can you do that on corporate or group or is that more relying on kind of the airlines too and everybody else?

You know, clearly, leisure is more responsive to price discounting immediately, but I think the group business particularly.

So those folks who know they are going to hold their meetings, and this is maybe a bit of wishful thinking, but the business is on sale and the values that are out there today are wonderful.

So if I'm looking at booking a piece of group business that I know with a high probability I'm going to have next year or I'm going to have in 2011, this is a pretty tempting time to book it because of those rates and to get them available.

And, again, it is -- none of us knows when we're going to see real recovery in economic activity which is the thing that's going to drive occupancy and demand.

But we all can be pretty certain that it's going to come and as it comes, the values that are available in this industry today will become less available.

So it's a great time to buy for not just leisure travelers but for others as well.

Right.

Great.

That's helpful.

Thanks.

For our next question we'll go to Smedes Rose with KBW Bank.

Hi, good morning.

Good morning.

I just had a couple of questions on timeshare.

Just want to understand, it looks like contract sales, you're still estimating around $800 million which has been the number for a while but the profitability continues to decline.

Is that primarily a function of these default triggers take place and your interest income gets subordinated, that's driving down the profits there through the financing area or is it more to do with reportability or what's kind of the main driver there?

Well, I think on your question relative to the default triggers, if you look what that affects is the value of your residual and we made an adjustment for that $12 million in the second quarter for the drop in the value of the residual, so we kind of took that out of the adjusted column relative to the effect of that.

I think what you're seeing is that, a couple things.

One, we had our incentive program in the second quarter and some of those profits or some of those sales we pulled from the third and fourth quarter that probably would have occurred.

The other thing is our services profits or services activity, which is renting the unsold week, so to speak, as transient rooms, that has dropped because REVPAR has dropped and those revenues offset unsold maintenance fee costs.

Unsold maintenance fees are what we pay on the unsold weeks and so those together with the increased weeks are putting pressure on our services profit.

So I see, I think you see those, both of those things are driving some of that.

And then, finally, we have this $8 million, $9 million tax item that's depressing the earnings in the second for the full year.

Okay, and then just another thing on that one.

You talked about the rating agencies.

I mean, did they currently assume Marriott's potential liability is around 20% of the securitized notes and, I mean, does that change if delinquencies continue to rise?

Or how do you think they're kind of thinking about that particularly now that you have to consolidate these notes?

Each rating agency looks at our timeshare securitizations a little differently.

I think they've looked at them consistently over time and they take, they obviously watch the delinquencies as we do as well.

Okay.

And then, Arne, just one last one.

On the international outlook, you've clearly reduced expectations, but it seems like the developing world, or China or Singapore or Asia, is kind of doing better than many people had thought.

I mean, is it mostly is Europe just doing really badly or maybe could you talk a little bit more about the segments besides the areas where there's political unrest?

It's everywhere and there's a somewhat different dynamic, so in China, for example, their economy, obviously, is better performing and forecasted to be better performing than much of the rest of the world.

But you've got still a tough travel environment which is compounded by meaningfully higher supply growth in China than we've seen probably anywhere else.

And so you look at the REVPAR numbers actually for that market and they are not meaningfully better.

In fact, in many respects are worse in many months than we've seen in the United States.

India is a much smaller market from a hotel perspective both for us and for the industry as a whole, but there with maybe a few remaining impacts of the Mumbai bombing.

I think probably more than that, though, it's an impact on global travel and the tech business very weak REVPAR.

And so I think that the stories are a little different as we talked about a quarter ago in the U.S., Washington D.C.

is still one of the relatively best markets.

I think as a region, we would say that maybe excluding Dubai, the Middle East is a relatively strong performer.

Saudi is strong.

Egypt is relatively strong and those are good markets.

Europe is actually about average for performance across the globe.

Thank you.

Big world out there.

Okay, thanks.

You bet.

For our next question we'll go to Steve Kent with Goldman Sachs.

Hi.

Good morning.

Good morning, Steve.

Two questions for you.

One, I thought that you mentioned, I think it was Carl who mentioned about incentive fees going forward that in the third quarter, because these were in resort locations maybe they would be a little bit softer.

Maybe you could just review that.

But maybe in a broader sense, if REVPAR stays negative for the next several quarters do you expect to get sort of no or very, very low incentive fees?

Does REVPAR have to turn positive for you to start to get incentive fees at this point?

So if you could explain those two issues?

And then just more broadly, Arne, it feels to me like the last time we went through a downturn in the cycle, there was a build-up of leisure travel and all of the people you're tapping right now, the teams, the sports teams, some of the meetings on weekends, and that created a lift of occupancy which then gave some of your hotel owners and managers some comfort of pushing price a little bit as they got further along.

This seems worse than the last time, but I mean is that sort of the normal trajectory for how this industry recovers or your experience of recovery?

Let me take that one first and then Carl can jump in and talk about the incentive fee performance.

I think there are bits of this which are normal.

I use that word with some caution because there's a lot about this downturn that doesn't feel very normal.

It is not unusual for leisure customers to be more loved by higher end hotels in weaker markets and pursued more aggressively.

It is not unusual for leisure travelers to respond more quickly to discounting and, therefore, to fill in some of these lower demand periods.

And, obviously, the better leisure performs the more that will drive relatively improved confidence both in terms of pricing for the rest of the hotel and among our teams out there in the hotels and the like.

Having said that, we probably are not going to be able to drive significant pricing growth on leisure customers only.

I think as we get into the fall, we're going to need to see business travelers and group rebook and get back on the road, and until we start to see demand grow in that space, I think we'll continue to have pressure on rates.

Carl, do you want to talk about--

Yes, on the incentive fees, Steve, your question about the resorts, we use that as an example, but when you record incentive fees you do it on a cumulative basis throughout the year and you do kind of catch-up adjustment, so to speak, each quarter on a cumulative basis.

So you take a resort and it earns a lot of money in the first quarter, records an incentive fee, and then in the third quarter which is very slow period you'll have an adjustment to bring that to a cumulative number.

What you're seeing is that a number of hotels that used to pay incentive fees aren't paying incentive fees now because you're now below the owner's priority and so it's becoming more pronounced as these cumulative adjustments take hold and that's the phenomenon you're seeing.

And then as the international markets get soft, even in those cases where we're earning a fee right off the first dollars of operating profit, operating profits dropping internationally as well as REVPAR drops internationally, despite the efforts made by our folks to hold margins.

What will we need to keep things flat?

I guess it would be margins would have to stay flat to hold the incentive fees flat at this point.

But we don't need, Steve, you asked do you need, I think you asked do you need positive REVPAR to see incentive fees?

We think we'll do $100 million plus of incentive fees this year with, obviously, massively negative REVPAR.

We don't need for REVPAR to be positive next year in order to have the first dollar, obviously, of incentive fees.

We can still make $100 million plus of incentive fees and, again, it depends, obviously, on the cost environment and exactly where REVPAR is, but we've got still a possibility of making good incentive fees going forward.

Just to carry that forward, if REVPAR negatives, the negative growth trajectory gets less worse or less better whatever people talk about are the second derivative improves the same thing can happen on incentive fees that they can start to tick up?

Yes, generally, negative REVPAR is going to be a negative influence on incentive fees.

It doesn't take it to zero.

Right.

But it would likely continue to reduce until such time as REVPAR is positive and then you'll start to see the increases.

Also remember that with fewer hotels earning incentive fees that the incentive fees are going to be dependent on performance at those particular hotels so it's not necessarily the case but a systemwide number represents what's going on in those particular hotels.

Okay, thanks, Laura.

Thanks, Arne.

Thanks, Carl.

Bye.

Next we'll go to JMP Securities, Will Marks.

Good morning, everyone.

Good morning.

Hi.

A couple of questions.

Can you remind us what international is as a percentage of total these days, either revenues or however you want to describe it?

It's about 25% to 30% of fees.

Okay, and it seems, based on the guidance that's where really the only surprise is versus April in terms of your hotel business, but you're also saying that you're seeing a shift in rate versus occupancy, so maybe can you help me understand that?

Yes, I think I understand your question.

Obviously, our REVPAR, our assumption for REVPAR for the full year we've not changed.

Our second quarter numbers were about what we anticipated, but maybe on the positive side, the optimistic side, of what we anticipated for the second quarter.

And so you look at that and you say, okay, well, why then does the assumption about total fees for the full year change, so assuming that's what you're asking--

Yes.

There are, obviously, a number of factors that go into that, but the two most significant ones you just referred to, so you've got international REVPAR which we now expect to be meaningfully worse than we did a quarter ago, order of magnitude five points I suppose, something like that.

And on incentive fees, we've got basically while REVPAR is about the same, we've got relatively stronger performance in occupancy and relatively weaker performance in rate with, therefore, greater pressure on margins and a greater impact on incentive fees.

Those would be the two most significant pieces, I think, that is driving that full year fee number.

Is that what you were asking?

Yes, I was and I know you're repeating yourself or making you repeat yourself, but I wanted to make sure I was clear.

Yes.

Also, on the -- a big issue these days is certainly the trading of ADR for occupancy, and can you discuss along different segment levels where you're -- obviously, it's a luxury and we're definitely seeing it, are you seeing it all the way down?

We're seeing rate declines in every brand, yes, every segment.

I'm sorry, actually what I meant was has there been a change in the last few months where, because it seems like if you look at the weekly Smith Travel numbers the rate of REVPAR decline hasn't changed that much, and the tradeoff of rate versus occupancy is happening much more at the high end, meaning it's gotten much worse in the ADR, but at the lower end it doesn't seem like if the ADR has shifted that much?

Yes, well -- go ahead, Carl.

Well, I was just going to say occupancy is starting to level off, but what you're seeing is that the price sensitivity continues to put pressure on REVPAR.

So what's happened is over the last several months, you've seen, or several periods, you've seen occupancy leveling off in the mid-60s, but continued rate pressure and because the occupancy has leveled off at a lower rate, you don't have pricing power yet.

Okay.

You look at our quarterly results by brand and you can see rate at double-digit declines for all full service and worst in the luxury, Ritz-Carlton, and the limited service brands -- Courtyard is about in the same area because it's 100% transient and mostly business travelers.

And the other limited service brands, the rate declines are a bit less at high single-digits and that may be what's behind your question.

But we're still talking about in limited service brands rate declines in our second quarter nearly 10%, 8% or 9%.

And when you look at either our data or you look at the Smith Travel industry-wide data, you can plot from November or first of December 2007 until today by month and you've got to adjust it a little bit for some funkiness in holidays but by month a shifting.

And initially the weakening in REVPAR growth was driven by occupancy declines.

Rate was still very, very strong, but in every period since then the rate growth and now declines have gotten worse month-by-month.

And I think that's true for every segment.

Okay.

That answers the question.

Thank you.

You bet.

Next we'll go to Joseph Greff with JPMorgan.

Good morning, everyone.

Good morning.

I had a follow-up question on some of your earlier comments, Arne, about group business for 2010-2011 and now's an opportune time to do it from a pricing perspective.

For the 2010-2011 corporate group business that you have on the books, how does that basket of pricing compare to 2009 pricing on group?

Let's see, I think it's flattish, maybe down a bit.

I mean, the bigger impact is in occupancy, and we've got business on the books for next year compared to this same time last year for this year is down significantly high teens year-over-year or about 20%, and that is -- but as we talked about a quarter ago, that's not a very meaningful number because a lot of the business that was on the books last year for this year has already been cancelled or attrited down.

And so we don't have a very meaningful statistic on pace which is really the occupancy equivalent.

On the group, the pricing is, it's not been terribly impacted yet, in part because there's a higher percentage of the group business that's on the books for next year which was booked really prior to when the wheels came off last fall.

Okay.

Do you think, though, this time next year that pace is a more relevant metric just given the narrowing in rate between transient and group that there's maybe less of a booking out of the block from a corporate rate or a group rate into a transient rate?

Or is that sort of an optimistic way of--

I'm not really sure I understand.

I think pace is going to lead us out.

Eventually.

Right now, we have a very short booking.

So the meeting planners and the bookers, they're sitting on the sidelines waiting to see if they can get a better deal, looking for better pricing, and so you got a very short window right now.

I guess part of your question is do we think as we move out of this volatility or out of the recession part, will we see that booking window lengthen, and probably.

I mean, you would expect it to do that.

As occupancy moves up, then there will be a need to book further and further out so that booking window will expand but right now it's pretty short.

And then a question on the composition of the development pipeline, how much of that is under construction right now, how much of that is international, how much of that is domestic limited service?

About 50% of it is under construction, we've got another 6% or 7% that is conversions, so if you put those two together, probably 57%, 58% is the equivalent of under construction or conversions.

I don't know, what was the second question you had there?

How much is international?

Oh, how much is international.

I think 30% is international.

And if you think of it in terms of full service, probably 60% of our total pipeline is limited service in North America, predominantly franchise.

The other 40% being full service and the majority of that would be outside the United States.

Okay, I know you don't want to talk about 2010 in any great detail, but based on those numbers, those statistics, do you feel confident that you can add 30,000 gross rooms in 2010?

I don't think we've given a number yet for 2010, but we feel good that we'll continue to add rooms in 2010 in a healthy way, just given the pipeline and what's under construction and what's in it.

Good enough.

Thank you, guys.

You bet.

Our next question will go to Felicia Hendrix with Barclays Capital.

Hi, guys.

Laura, it's good to hear your voice.

Thank you.

It's nice to be back.

Yes, I'm sure.

A few questions.

Arne, a while back in this call you had talked about work outs and how you're spending some time with managers and particularly probably the managed guys on that.

I was just wondering what percentage of your managed and franchised hotels are in some kind of state of payment default and on their debt service and to the extent that you are engaged in work out discussions I'm just wondering is there any way you could give us a magnitude of where that is, maybe relative to prior similar periods?

Those are all great questions.

I think in terms of cash defaults on debt service we think the number of hotels that are in that situation are very, very few.

The hotels which are under the most pressure from a long-term perspective probably were financed in 2005, 2006, 2007, something like that, towards the end of the cycle.

And if they were financed aggressively, there are questions about how much debt those things can support long term.

The positive piece, though, is much of that financing was done floating rate and if it's floating rate, those owners have gotten the benefit of very low current interest rates.

And so as a consequence the cash defaults are really not that high.

It's more a question of longer term how do those deals get structured in a way that makes sure they are stable.

And we are in communication with our owners and franchisees a lot, but we don't have direct data in our system about the details necessarily of their financing so there are many statistics we really can't give you.

I think, though, that if you compare this to 2001, 2002, and 2003, we are still right now what -- the wheels changed dramatically in the fall of 2008, so we're really three quarters into a tough REVPAR environment, if you really look at 2009 where it's been the most severe we've been through two quarters.

I think the big questions we're going to have to watch are how long does it continue and if we can hopefully see some kind of recovery that is meaningful in 2010 that will have a profound impact into the way both owners and lenders view these projects.

And I think we are all as an industry collectively working to get a few more quarters down the road in the hopes that we're going to see some recovery and that will have an impact into the way these deals get dealt with.

And then in terms of when you use the terms work outs we've been hearing all brands have been offering those owners who are having difficulties certain concession and deferrals and that sort of thing, I mean, when you're having these discussions even though they are a few, what sort of discussions are they, what sort of path are they taking?

Yes, and I think the word "work outs" is, it sort of implies a conclusion of some set of negotiations.

We're not at the stage where work outs are being completed, and so maybe I used that word inadvisedly.

But what we are doing is working with our owners and franchisees to be prepared to ultimately see how those things can get restructured, if they can get restructured.

Okay.

Because we know that that pressure is already there, but, again, that pressure has not been there long enough usually and in an overwhelming majority of cases to write them into something definitive yet.

And I think in the meantime, we've got a lot of structural benefits in our business model.

We have management contracts that overwhelmingly include non-disturbance agreements from the lenders.

We are usually in position in the managed hotels to control the cash and to make sure that we aren't letting receivables run up or in some other way financing the system.

And so we're doing everything we can to protect our situation and not become a lender to hotels that are under pressure.

But at the same time the owners and franchisees are hugely important customers and partners of ours and we've got to make sure we're working with them to do everything we can consistent with our needs to make sure that they can survive.

Okay, and then just switching gears, I was wondering, can you give us the metric in the quarter for your pipeline around your conversion versus new hotels and maybe how that compared to the last quarter 2008?

We had two hotel conversions in the second quarter.

So of our total hotels, it wasn't a material number of the total.

I think we're expecting somewhere between 7% and 10% of our hotels added in 2009 to be conversion.

And then is that, I know I could look it up, but just how does that compare to 2008 second quarter?

I don't have that.

We'll have to get back to you on that one.

Yes, you have that in your [file.]

One of the things, as Arne mentioned when he was talking, right now you haven't seen a lot of activity relative to the lenders or properties going back to banks and all that.

The lenders are working with owners.

We would suspect that when and if that does start happening within the industry, we'll get more than our fair share of conversions as portfolios start changing hands.

Okay.

And then just --

All right, Felicia, thank you very much.

I think we're at our time, right?

And thank you all very much for participating in this morning's call.

There's, as always we encourage you to get back out on the road.

There are great values out there and snap them up before they disappear.

Thanks for your time.

Once again that does conclude our conference for today.

Thank you, again, for your participation and have a wonderful day.