Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and costs and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those relating to revenue recognition, bad debts, inventories, investments, plant, property and equipment, goodwill and intangible assets, income taxes, financing operations, frequent guest program liability, self-insurance claims payable, restructuring costs, retirement benefits and contingencies and litigation.

Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions and conditions.

We believe the following to be our critical accounting policies:

Revenue Recognition. Our revenues are primarily derived from the following sources: (1) hotel and resort revenues at our owned, leased and consolidated joint venture properties; (2) vacation ownership and residential revenues;
(3) management and franchise revenues; (4) revenues from managed and franchised properties; and (5) other revenues which are ancillary to our operations. Generally, revenues are recognized when the services have been rendered. The following is a description of the composition of our revenues:

• Owned, Leased and Consolidated Joint Ventures - Represents revenue primarily derived from hotel operations, including the rental of rooms and food and beverage sales from owned, leased or consolidated joint venture hotels and resorts. Revenue is recognized when rooms are occupied and services have been rendered. These revenues are impacted by global economic conditions affecting the travel and hospitality industry as well as relative market share of the local competitive set of hotels. REVPAR is a leading indicator of revenue trends at owned, leased and consolidated joint venture hotels as it measures the period-over-period growth in rooms revenue for comparable properties.

• Vacation Ownership and Residential - We recognize revenue from VOI sales and financings and the sales of residential units which are typically a component of mixed use projects that include a hotel. Such revenues are impacted by the state of the global economies and, in particular, the U.S. economy, as well as interest rate and other economic conditions affecting the lending market. Revenue is generally recognized upon the buyer demonstrating a sufficient level of initial and continuing investment, the period of cancellation with refund has expired and receivables are deemed collectible. We determine the portion of revenues to recognize for sales accounted for under the percentage of completion method based on judgments and estimates including total project costs to complete. Additionally, we record reserves against these revenues based on expected default levels. Changes in costs could lead to adjustments to the percentage of completion status of a project, which may result in differences in the timing and amount of revenues recognized from the projects. We have also entered into licensing agreements with third-party developers to offer consumers branded condominiums or residences. Our fees from these agreements are generally based on the gross sales revenue of units sold. Residential fee revenue is recorded in the period that a purchase and sales agreement exists, delivery of services and obligations has occurred, the fee to the owner is deemed fixed and determinable and collectibility of the fees is reasonably assured.

• Management and Franchise Revenues - Represents fees earned on hotels managed worldwide, usually under long-term contracts, franchise fees received in connection with the franchise of our Sheraton, Westin, Four Points by Sheraton, Le Méridien and Luxury Collection brand names, termination fees and the amortization of deferred gains related to sold properties for which we have significant continuing involvement, offset by payments by us under performance and other guarantees. Management fees are comprised of a base fee, which is generally based on a percentage of gross revenues, and an incentive fee, which is generally based on the property's profitability. For any time during the year, when the provisions of our management contracts allow receipt of incentive fees upon termination, incentive fees are recognized for the fees due and earned as if the contract was terminated at that date, exclusive of any termination fees due or payable. Therefore, during periods prior to year-end, the incentive fees recorded may not be indicative of the eventual incentive fees that will be recognized at year-end as conditions and incentive hurdle calculations may not be final. Franchise fees are generally based on a percentage of hotel room revenues. As with hotel revenues discussed above, these revenue sources are affected by conditions impacting the travel and hospitality industry as well as competition from other hotel management and franchise companies.

• Revenues from Managed and Franchised Properties - These revenues represent reimbursements of costs incurred on behalf of managed hotel properties and franchisees. These costs relate primarily to payroll costs at managed properties where we are the employer. Since the reimbursements are made based upon the costs incurred with no added margin, these revenues and corresponding expenses have no effect on our operating income and our net income.

Frequent Guest Program. SPG is our frequent guest incentive marketing program. SPG members earn points based on spending at our properties, as incentives to first time buyers of VOIs and residences and through participation in affiliated programs. Points can be redeemed at substantially all of our owned, leased, managed and franchised properties as well as through other redemption opportunities with third parties, such as conversion to airline miles. Properties are charged based on hotel guests' qualifying expenditures. Revenue is recognized by participating hotels and resorts when points are redeemed for hotel stays.

We, through the services of third-party actuarial analysts, determine the fair value of the future redemption obligation based on statistical formulas which project the timing of future point redemption based on historical experience, including an estimate of the "breakage" for points that will never be redeemed, and an estimate of the points that will eventually be redeemed as well as the cost of reimbursing hotels and other third parties in respect of other redemption opportunities for point redemptions. Actual expenditures for SPG may differ from the actuarially determined liability. The total actuarially determined liability as of December 31, 2008 and 2007 is $662 million and $536 million, respectively. A 10% reduction in the "breakage" of points would result in an estimated increase of $85 million to the liability at December 31, 2008.

Long-Lived Assets. We evaluate the carrying value of our long-lived assets for impairment by comparing the expected undiscounted future cash flows of the assets to the net book value of the assets if certain trigger events occur. If the expected undiscounted future cash flows are less than the net book value of the assets, the excess of the net book value over the estimated fair value is charged to current earnings. Fair value is based upon discounted cash flows of the assets at a rate deemed reasonable for the type of asset and prevailing market conditions, appraisals and, if appropriate, current estimated net sales proceeds from pending offers. We evaluate the carrying value of our long-lived assets based on our plans, at the time, for such assets and such qualitative factors as future development in the surrounding area, status of expected local competition and projected incremental income from renovations. Changes to our plans, including a decision to dispose of or change the intended use of an asset, can have a material impact on the carrying value of the asset.

Loan Loss Reserves. For the vacation ownership and residential segment, we record an estimate of expected uncollectibility on our VOI notes receivable as a reduction of revenue at the time we recognize profit on a sale of a vacation ownership interest. We hold large amounts of homogeneous VOI notes receivable and therefore assess uncollectibility based on pools of receivables. In estimating our loss reserves, we use a technique referred to as static pool analysis, which tracks uncollectible notes for each year's sales over the life of the respective notes and projects an estimated default rate that is used in the determination of our loan loss reserve requirements. As of December 31, 2008, the average estimated default rate for our pools of receivables was 7.9%. Given the significance of our respective pools of VOI notes receivable, a change in the projected default rate can have a significant impact to our loan loss reserve requirements, with a 0.1% change estimated to have an impact of approximately $3 million.

For the hotel segment, we measure the impairment of a loan based on the present value of expected future cash flows discounted at the loan's original effective interest rate or the estimated fair value of the collateral. For impaired loans, we establish a specific impairment reserve for the difference between the recorded investment in the loan and the present value of the expected future cash flows or the estimated fair value of the collateral. We apply the loan impairment policy individually to all loans in the portfolio and do not aggregate loans for the purpose of applying such policy. For loans that we have determined to be impaired, we recognize interest income on a cash basis.

Assets Held for Sale. We consider properties to be assets held for sale when management approves and commits to a formal plan to actively market a property or group of properties for sale and a signed sales contract and significant non-refundable deposit or contract break-up fee exist. Upon designation as an asset held for sale, we record the carrying value of each property or group of properties at the lower of its carrying value which includes allocable segment goodwill or its estimated fair value, less estimated costs to sell, and we stop recording depreciation expense. Any gain realized in connection with the sale of a property for which we have significant continuing involvement (such as through a long-term management agreement) is deferred and recognized over the initial term of the related agreement. The operations of the properties held for sale prior to the sale date are recorded in discontinued operations unless we will have continuing involvement (such as through a management or franchise agreement) after the sale.

Legal Contingencies. We are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies," requires that an estimated loss from a loss contingency should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or our results of operations.

Income Taxes. We provide for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," and Financial Accounting Standards Board Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns.

The following discussion presents an analysis of results of our operations for the years ended December 31, 2008, 2007 and 2006.

Year Ended December 31, 2008 Compared with Year Ended December 31, 2007

Continuing Operations


                                                                                      Increase/       Percentage
                                                  Year Ended        Year Ended       (Decrease)         Change
                                                 December 31,      December 31,      from Prior       from Prior
                                                     2008              2007             Year             Year

Owned, Leased and Consolidated Joint Venture
Hotels                                           $       2,259     $       2,429     $      (170 )           (7.0 )%
Management Fees, Franchise Fees and Other
Income                                                     857               834              23              2.8 %
Vacation Ownership and Residential                         749             1,025            (276 )          (26.9 )%
Other Revenues from Managed and Franchise
Properties                                               2,042             1,865             177              9.5 %

Total Revenues                                   $       5,907     $       6,153     $      (246 )           (4.0 )%

The decrease in revenues from owned, leased and consolidated joint venture hotels was partially due to lost revenues from 19 wholly owned hotels sold or closed in 2008 and 2007. These sold or closed hotels had revenues of $77 million in the year ended December 31, 2008 compared to $121 million in the corresponding period of 2007. Revenues at our Same-Store Owned Hotels (59 hotels for the year ended December 31, 2008 and 2007, excluding the 19 hotels sold or closed and 10 additional hotels undergoing significant repositionings or without comparable results in 2008 and 2007) decreased 1.5%, or $31 million, to $2.015 billion for the year ended December 31, 2008 when compared to $2.046 billion in the same period of 2007 due primarily to a decrease in REVPAR.

REVPAR at our Same-Store Owned Hotels decreased 1.2% to $168.93 for the year ended December 31, 2008 when compared to the corresponding 2007 period. The decrease in REVPAR at these Same-Store Owned Hotels resulted from a 1.0% increase in ADR to $237.45 for the year ended December 31, 2008 compared to $235.18 for the corresponding 2007 period and a decrease in occupancy rates to 71.1% in the year ended December 31, 2008 when compared to 72.7% in the same period in 2007. REVPAR at Same-Store Owned Hotels in North America decreased 1.9% for the year ended December 31, 2008 when compared to the same period of 2007. REVPAR declined in most of our major domestic markets, including Atlanta, Georgia, Kauai, Hawaii and New York, New York, due to the severe economic crisis in the United States, and globally. REVPAR at our international Same-Store Owned Hotels increased by 0.1% for the year ended December 31, 2008 when compared to the same period of 2007. Once again, due to the global economic crisis, REVPAR declined in most of our major international markets, including the United Kingdom and Italy. REVPAR for Same-Store Owned Hotels internationally increased 0.6% excluding the unfavorable effects of foreign currency translation.

The increase in management fees, franchise fees and other income was primarily a result of a $35 million increase in management and franchise revenue to $717 million for the year ended December 31, 2008. The increase was due to the net addition of 48 managed and franchised hotels to our system. Other income decreased $13 million primarily due to $18 million of income recognized in 2007 from the sale of a managed hotel that resulted in a payment of an $18 million fee to us.

The decrease in vacation ownership and residential sales and services was primarily due to an overall decline in demand as a result of the economic climate, and the timing of revenue recognition from ongoing projects under construction which are being accounted for under percentage of completion accounting. Originated contract sales of VOI inventory, which represents vacation ownership revenues before adjustments for percentage of completion accounting and rescission, decreased 26% in the year ended December 31, 2008 when compared to the same period in 2007. Additionally, sales in Hawaii were negatively impacted by the sell out of our largest project on Maui in early 2008. The decline in the vacation ownership business was partially offset by strong results in the residential

branding business. The increase in residential fees for the year ended December 31, 2008 to $49 million when compared to $18 million in 2007 was primarily related to fees earned from the St. Regis Singapore Residences, which opened during the year and a nonrefundable license fee received in connection with another residential project.

Other revenues and expenses from managed and franchised properties increased primarily due to an increase in the number of our managed and franchised hotels. These revenues represent reimbursements of costs incurred on behalf of managed hotel and vacation ownership properties and franchisees and relate primarily to payroll costs at managed properties where we are the employer. Since the reimbursements are made based upon the costs incurred with no added margin, these revenues and corresponding expenses have no effect on our operating income and our net income.

                                                                                    Increase/       Percentage
                                              Year Ended         Year Ended        (Decrease)         Change
                                             December 31,       December 31,       from Prior       from Prior
                                                 2008               2007              Year             Year

Selling, General, Administrative and Other   $         477      $         508      $       (31 )           (6.1 )%

The decrease in selling, general, administrative and other expenses was primarily a result of our focus on reducing our cost structure in light of the declining business conditions in this current economic climate. Beginning in the middle of 2008, we began an activity value analysis project to review our cost structure across a majority of our corporate departments and divisional headquarters. We have completed the first two phases of that program which has resulted in the majority of these cost savings and additional phases are expected to be completed in early 2009.

                                                                                    Increase/       Percentage
                                                Year Ended        Year Ended       (Decrease)         Change
                                               December 31,      December 31,      from Prior       from Prior
                                                   2008              2007             Year             Year

Restructuring and Other Special Charges, Net   $         141     $          53     $        88              n/a

During the year ended December 31, 2008, we recorded restructuring and other special charges of $141 million, including $62 million of severance and related charges associated with our ongoing initiative of rationalizing our cost structure in light of the current economic climate. We also recorded impairment charges of approximately $79 million primarily related to the decision not to develop two vacation ownership projects as a result of the current economic climate and its impact on business conditions in the timeshare industry (see Note 13 of the consolidated financial statements).

During the year ended December 31, 2007, we recorded $53 million in net restructuring and other special charges primarily related to accelerated depreciation of property, plant and equipment at the Sheraton Bal Harbour in Florida ("Bal Harbour") and demolition costs associated with our redevelopment of that hotel. Bal Harbour was closed for business on July 1, 2007, and the majority of its employees were terminated. The hotel was demolished and we are in the process of building a St. Regis hotel along with branded residences and fractional units.

                                                                                  Increase/        Percentage
                                            Year Ended         Year Ended        (Decrease)          Change
                                           December 31,       December 31,       from Prior        from Prior
                                               2008               2007              Year              Year

Depreciation and Amortization              $         323      $         306      $        17               5.6 %

The increase in depreciation expense was due to an increase in capital spending on our owned hotels partially offset by the impact of hotels sold or held for sale. The increase in amortization expense was primarily due to the write-off, through amortization expense, of an investment in a management contract during 2008.

                                                             Increase/       Percentage
                         Year Ended        Year Ended       (Decrease)         Change
                        December 31,      December 31,      from Prior       from Prior
                            2008              2007             Year             Year

     Operating Income   $         619     $         858     $      (239 )          (27.9 )%

The decrease in operating income was primarily due to the decrease in vacation ownership sales and services as well as the decrease in revenues from owned, leased and consolidated joint venture hotels discussed above.

                                                                                  Increase/        Percentage
                                            Year Ended         Year Ended        (Decrease)          Change
                                           December 31,       December 31,       from Prior        from Prior
                                               2008               2007              Year              Year

Equity Earnings and Gains and Losses
from Unconsolidated Ventures, Net          $          16      $          66      $       (50 )           (75.8 )%

The decrease in equity earnings and gains and losses from unconsolidated joint ventures was primarily due to our share of non-recurring gains, in 2007, on the sale of several hotels in an unconsolidated joint venture as well as decreased operating results, in 2008, at several properties owned by joint ventures in which we hold minority interests.

                                                                Increase/      Percentage
                            Year Ended        Year Ended       (Decrease)        Change
                           December 31,      December 31,      from Prior      from Prior
                               2008              2007             Year            Year

    Net Interest Expense   $         207     $         147     $        60            40.8 %

The increase in net interest expense was primarily due to increased borrowings to fund our share repurchase program. Our weighted average interest rate was 5.24% at December 31, 2008 versus 6.52% at December 31, 2007. The average debt balance during 2008 and 2007 was $3.802 billion and $3.114 billion respectively.

                                                                                       Increase/       Percentage
                                                   Year Ended        Year Ended       (Decrease)         Change
                                                  December 31,      December 31,      from Prior       from Prior
                                                      2008              2007             Year             Year

Loss on Asset Dispositions and Impairments, Net   $         (98 )   $         (44 )   $       (54 )            n/a

During 2008, we recorded a net loss of $98 million primarily related to $64 million of impairment charges on five hotels, a $22 million impairment of our investment in vacation ownership notes receivable that we have previously securitized, and an $11 million write-off of our investment in a joint venture in which we hold minority interest (see Note 5 of the consolidated financial statements).

During 2007, we recorded a net loss of $44 million primarily related to a net loss of $58 million on the sale of eight wholly-owned hotels and a loss of approximately $7 million primarily related to charges at three other properties. These losses were offset in part by $20 million of net gains primarily on the sale of assets in which we held a minority interest and a gain of $6 million as a result of insurance proceeds received for property damage caused by storms at two owned hotels in prior years.

                                                              Increase/       Percentage
                          Year Ended        Year Ended       (Decrease)         Change
                         December 31,      December 31,      from Prior       from Prior
                             2008              2007             Year             Year

    Income Tax Expense   $          76     $         189     $      (113 )          (59.8 )%

The decrease in income tax expense is primarily related to a decrease in pretax income and certain other one time tax benefits. The effective tax rate decreased to 23.0% in the year ended December 31, 2008 as compared to 25.8% in 2007. The 2008 tax rate was favorably impacted by a $31 million benefit related to the reversal of capital and net operating loss valuation allowances, a $20 million benefit related to lower foreign taxes, and a $14 million benefit associated with tax on the repatriation of foreign earnings. These benefits were partially . . .