Marriott International, Inc. (MAR)
Fiscal second quarter 2008 Earnings Call

Conducted on July 10, 2008 10:00 AM, ET

Executives
Arne Sorenson - Executive Vice President, CFO and President, Continental European Lodging
Laura Paugh - Vice President, Investor Relations
Carl Berquist - Executive Vice President, Financial Information and Enterprise Risk Management
Betsy Daum - Senior Director, Investor Relations

Analysts
Felicia Hendrix – Lehman Brothers
Celeste Brown - Morgan Stanley
Joseph Greff – JP Morgan
Patrick Sholes – SBR Capital Markets
Steve Kent - Goldman Sachs
Bill Crow - Raymond James
Smedes Rose - KBW
William Truelove - UBS
Will Marks - JMP Securities
Chris Woronka – Deutsche Bank
Michael Millman – Soleil Securities

Presentation

Operator
Hello and welcome to the Marriott International Second Quarter 2008 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 Executive Vice President, Chief Financial Officer and President of the Continental European Lodging, Mr. Arne Sorenson. Please go ahead sir.

Arne Sorenson
Thank you, Kim. Good morning everyone. Welcome to our second quarter 2008 earnings conference call. Joining me today are Laura Paugh, Senior Vice President, Investor Relations, Carl Berquist, Executive Vice President, Financial Information and Enterprise Risk Management and Betsy Daum, Senior Director, Investor Relations. Before I get into the discussion of our results let me first remind everyone that many of our comments today are not historical facts and are considered forward looking statements under Federal Securities Laws. These statements are subject to numerous risks and uncertainties as described in our SEC filings which could cause future results to differ materially from those expressed in or implied by our comments.

Forward-looking statements in the press release that we issued this morning along with our comments today are effective only today July 10, 2008, and will not be updated as actual events unfold. You can find a reconciliation of our non-GAAP financial measures referred to in our remarks at our website at www.marriott.com/Investor.

I know that all of you are interested in the specific results for the quarter and especially our outlook; we’ll get to that shortly. I’d like to start though by setting the stage for the quarter. No one listening today will be surprised to hear that the slowdown in the US economy has impacted our business. In early June general economic conditions in the US led us to ratchet back our North American RevPAR guidance for the second quarter from a range of 3% to 5% growth to roughly 2% for North American company operated hotels. We finished the quarter at 1.4% RevPAR growth for these properties. If anything, since the first week in June the economic climate in the US has turned more bearish causing prices to continue to decline. Oil has generally continued its rapid upward march and the airlines are raising fares and cutting flights. To top it off, consumer confidence is at a 28 year low.

There are of course contradictory data points but by and large it appears that economic activity in the US continues to soften. All is not gloomy. However; outside of North America RevPAR for company operated comparable hotels grew over 15% in the second quarter including the impact of foreign exchange or 7.2% excluding the foreign exchange impact. World wide our associates are doing an outstanding job given the environment, finding ways to both drive revenue and control costs both on property and above property. I’ll talk more about that in a minute. Our timeshare business also is seeing the impact of the economy. Relatively speaking our core weekly timeshare business held its steadiest while fractional and residential projects had the biggest challenges during the quarter. We demonstrated our access to the credit markets during the quarter. We had planned to raise $150 million from note sales but investors actually bought $246 million. This gave us a bigger gain than expected even though interest rate spreads were a bit wider than we forecasted.

The financing environment for US hotels is getting tighter. As a result new full service hotel development may involve several lenders with modest overall leverage. For smaller projects, small banks are still providing loans to franchisees typically under $15 million and for relationship customers. Of course all of this should result in lower US supply growth particularly in 2010 and beyond. Outside the US the European and Latin American markets also have tougher financing environments than they did but in Asia and the Middle East financing is not an issue. Let’s turn to some additional details for the quarter. As you saw earlier this morning we reported diluted earnings per share from continuing operations of $0.41 which included a $0.10 negative impact of some special non-cash items in our tax line. We took a $24 million reserve related to the treatment of funds received from foreign subsidiaries. While we booked this reserve in the second quarter we remain in discussions with the IRS regarding the matter and believe we should ultimately prevail. The remaining charge totaled $12 million and was largely due to a settlement we reached in May with the IRS involving a 1995 leasing transaction.


As part of that agreement we recently received $26 million in cash tax refunds which unfortunately was somewhat less than we expected. Excluding the impact of these items our EPS ended the quarter at $0.51 near the top end of the guidance we provided a quarter ago. In North America comparable system wide properties increased RevPAR 1.2% with full service and luxury properties up 1.9% during the quarter. RevPAR for our comparable system wide limited service hotels which do not benefit from significant group business increased modestly up 0.5% reflecting continuing soft transient business, particularly on weekends. As you know our second quarter includes the 12 weeks ending on June 13, adjusted to a calendar basis our North American second quarter RevPAR would have been about another percentage point higher reflecting this year’s Easter timing. Back in our quarter group business at the Marriott brand was strong with property revenue up over 6% during the quarter although cancellations were a bit higher than last year and group attendance was slightly lower.

A significant group issue is new bookings including those for the current year. A few meeting planners seem to be delaying booking new business. For the rest of 2008 the group revenue on the books for our Marriott brand is running over 5% ahead compared to the same time last year. For 2009 group revenue pace is up just shy of 4% over 2008 levels. We estimate that we have nearly half of our likely 2009 group business already on the books. Given this RevPAR environment, we’ve increased our focus on the cost side. Every hotel has a contingency plan and all domestic properties have implemented those plans. Cost savings range from modifying menus and restaurant hours to mandatory vacations and hiring freezes. The savings are not just on property. We also have cuts above property costs that are allocated to the hotels scaling back programs to be roughly flat relative to revenue. Our marketing teams have deployed resources to focus on revenue generation such as our Internet channels targeting messages to our rich store of email addresses drawn from our nearly 30 million Marriott Rewards Members. We’ve also rolled out a number of promotions offering a range of amenities to entice vacation travelers.

For meeting planners we’re enticing them with our Spirit to Preserve the Rainforest promotion, which I’ll talk about more in a few minutes. We’re also just starting a promotion aimed at affinity groups such as family reunions, kid’s sports teams, and sports fans. We’re calling it ‘Champion the Weekends.’ Across our system, our North America hotels are focusing on growing the contribution of non-room sales. During the quarter banquet sales rose 6.4% and food and beverage profit margins that are comparable company operated Marriott hotels rose, 90 basis points. All in all despite a weak RevPAR environment, house profit dollars per available room rose almost 1% in North America during the second quarter. Of course it’s worth mentioning that demand is not soft everywhere. In our Marriott Brand our Downtown Hotels RevPAR rose 4.8% and our Resort RevPAR rose 5.6%, reflecting the relatively greater strength in group business. In New York our full service hotels RevPAR rose just over 7% for the second quarter. The market continues to benefit from international inbound guests attracted to the wares of 5th Avenue at fire sale prices at least for them.

I wanted to add a quick note about New Orleans, we haven’t talked about it much in recent quarters but we want to celebrate some good news for that city. Demand far outpaces new supply and the market turned in RevPAR growth of over 11% during the second quarter. The first quarter 2008 was actually stronger than 2005’s first quarter before Katrina. Air lift to the city is up 14% year-over-year through April and our transient room nights in the Big Easy are up 25% year to date. Turning to our International markets, the Middle East is doing spectacularly well. During the second quarter company operated RevPAR in the region rose 22% including 20% in Dubai and 32% in Egypt. With the Olympics in Beijing just about a month away, we’re extremely well positioned in the market and across China. Elsewhere in the region our Central and Southeast Asian properties did just great. All but five hotels reported double digit RevPAR. The UK continues to experience at some levels similar economic conditions to the US and RevPAR growth was in the low single digits during the quarter but we’re doing some very important things to position ourselves in the UK that we think will pay great dividends. We’ve taken down our flag from a few properties and our owners are investing about £240 million or about $475 million at our remaining properties to remake our brands across the UK.

In the Caribbean our resorts did well during the quarter and are seeing an increase from international visitors particularly Curacao and Grand Cayman. In South and Central America full service business hotels in major cities are performing quite well with some reporting second quarter RevPAR gains of 20% or even higher, while same store performance is an important part of our growth story, adding new units is another. At the end of the second quarter our worldwide pipeline of hotels totaled over 130,000 rooms, 60,000 of those rooms are already under construction. We opened more than 9,400 rooms during the second quarter just about a quarter of them outside North America. We closed approximately 2,400 rooms as we refresh our system and therefore ended the quarter with the portfolio of about 545,000 hotel rooms across the globe. We opened our first hotel outside the US 33 years ago in Amsterdam and today that portfolio has grown to over 400 hotels. In May, Bill Marriott signed development agreements in the Middle East that brought our pipeline to more than double the properties we currently operate in the region. We’re also opening our first timeshare product in the region in Dubai, Festival City.

In China we just opened our second Courtyard in the Chinese capital this past quarter and our first Courtyard in Hong Kong and it is stunning. We also opened a new Marriott in Ningbo, an historic port city that’s home to more than five million. Our future continues to look bright in China. During the quarter we announced nine more development transactions that have increased our pipeline there to 23 properties. When all these projects are completed the number of our properties in China will have grown from 37 today to 60 in 2011. Virtually all of them sizable, full service and luxury hotels. As I mentioned earlier, our timeshare business is starting to see the impact of the softer economy. During the quarter, contract sales of our fractional products declined by approximately half. Sales of our residential products declined 17% and contract sales at our core time share business declined 2%.
With some residential sales expected to close we still expect fractional and residential to account for about 20% of contract sales in 2008. For our core timeshare product we increased our marketing incentives during the quarter offering attractive tour packages and Marriott Rewards points at closing. We are not discounting products. Our Asia Pacific points program is doing well and we’ve seen an increase in buyers from Latin America and Asia. As I discussed a few minutes ago, investors purchased $246 million in timeshare mortgage notes in the quarter and we booked a $29 million gain. Our loan portfolio is doing fine; US delinquencies were up only slightly in June to 6.6% compared to 6.4% at the end of March.

Now let’s turn to our outlook. We are more concerned about US lodging demands today than when we last talked in April. With softer mid-week transient demand and weaker near-term group bookings, we are forecasting third quarter comparable North American company operated RevPAR flat to down 2% yielding full year North American RevPAR ranging from down 1% to plus 1%. Given this environment we do not expect much improvement until 2009. As a housekeeping issue it’s worth noting that our RevPAR guidance is based on a typical 52 week year. In fact, Marriott’s fiscal year 2008 ends on January 2, 2009, and this year includes, 53 weeks. This is a very modest positive for profit comparisons during the year since we are comparing profits to a 52 week 2007. When actual RevPAR statistics are reported for our fourth quarter it will be a cosmetic negative since we will be comparing a seasonably slow week to a non-comparable period so don’t be alarmed. The 52 week statistics represent the real operating trend. All our guidance comments are based on a normalized 52 week year. By the way, our last catch up 53 week year was in 2002. On a worldwide basis we expect system wide RevPAR to be flat up 2% for the year in constant dollars. Despite softness in demand in North America we continue to see significant demand growth in many regions of the world.

As we think about our fee forecast recall that base management and franchise fees are derived from world wide RevPAR and unit growth. Incentive management fees are derived from world wide hotel profitability. Today our international hotels contribute 35% to 40% of our incentive fees and in the second quarter nine of the top 20 incentive fee paying hotels were outside the US. In fact, eight of the nine are located in Asia or the Middle East. As International hotels increase in number their importance to incentive fees is growing. You may recall that in 2000 only 15% of our incentive fees came from International hotels. With more than 130,000 room pipeline we are confident in our 30,000 room gross additions expected in 2008 and we believe we can achieve $1.45 to $1.475 billion in total fee revenue in 2008. Incidentally we believe we can open 30,000 to 35,000 rooms in 2009. Most of those rooms are already under construction.