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Starwood Hotels & Resorts Worldwide Inc. (NYSE:HOT)

Q4 2008 Earnings Call

January 29, 2009 10:30 am ET

Executives

Jason Koval – Vice President of Investor Relations

Frits van Paasschen – Chief Executive Officer

Vasant M Prabhu – Chief Financial Officer

Analysts

Celeste Brown - Morgan Stanley

Joseph Greff - J.P. Morgan

David Katz - Oppenheimer & Co.

Felicia Hendrix - Barclays Capital

[David Low] – Robert W. Baird

Patrick Scholes - Friedman, Billings, Ramsey & Co.

Smedes Rose - Keefe, Bruyette & Woods

Chris Woronka - Deutsche Bank Securities

William Marks - JMP Securities

William Truelove - UBS

Michael Stone - dealReporter

Operator

Good day and welcome to the Starwood Hotel and Resorts fourth quarter 2008 earnings release 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 the Vice President of Investor Relations, Mr. Jason Koval. Please go ahead sir.

Jason Koval

Thank you [Tamra] and good morning everyone. Thanks for joining us this morning for Starwood’s fourth quarter 2008 earnings call. Joining me today I have Frits van Paasschen, our CEO; and Vasant Prabhu, our CFO.

We will be making statements on this call related to company plans, prospects and expectations that constitute forward-looking statements under the safe harbor provision of the Securities Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as Starwood or its management believes; expects; anticipates; perceives; forecasts; estimates; or other words or phrases of similar import.

All such statements are based on our expectations as of today and should not be relied upon as representing our expectations of any subsequent date. Actual results might differ from our discussions today. I point you to our 10-K and other SEC filings available from the SEC or through our offices here and on our website at StarwoodHotels.com for some of the factors that could cause results to differ.

With that I am pleased to turn the call over to Frits for his comments. Frits.

Frits van Paasschen

Thank you Jay and thanks all of you for joining us on our call. Before going into today’s call, I’d like to share some quick thoughts on the current operating environment. On our last call, Vasant gave you some color on the RevPAR deceleration that we experienced from the third quarter into October. Not only did these trends persist through the fourth quarter, but in most cases they deteriorated further, driven by businesses cutting back on travel and skittish consumers putting leisure travel on hold.

If we learned anything in 2008, it’s to expect the unexpected, to prepare for the worst and to keep our nerve. One thing we can say is that momentum continues to be negative as markets that were already slow have worsened, and as geographies and sectors that were previously robust begin to falter.

With that, there are four main topics I’d like to cover in today’s earning call. First, a brief recap on our results from the fourth quarter. Second, our 2009 baseline scenario focusing on how our lower cost structure and reduced capital outlays will help us sustain EBITDA and EPS in the face of declining RevPAR.

Third, more detail on our three-pronged approach to cost cutting. This includes some examples of how we aim to reduce our overhead costs on a full-year basis by $100 million, and how we’ll cut fixed property levels costs by 3 to 4% in 2009. This is in addition to the variable cost reductions you would normally expect from contingency plans as occupancy levels decline. And fourth, I want to reaffirm our long term vision for Starwood.

So let’s dig into the first topic, our fourth quarter results. RevPAR came in well below expectations. In the spirit of planning for the worst, though, we acted early to cut costs and still delivered EBITDA of $273 million and $0.49, both well ahead of consensus. Latin America, Africa and the Middle East began the quarter well, but by December the economic crisis grew deeper and continued to spread, leaving the negative RevPAR pretty much all around the globe. At the same time, RevPAR at our own hotels continued to drop, down 16% in constant dollars.

One of our core strengths is our portfolio of luxury properties and our presence in places like New York. At the moment, however, these strengths turned against us as weak leisure demand from U.S. travelers hurt our unique destination resorts in Hawaii, Mexico and Europe, not to mention the acute slowdown in New York. Despite these conditions, we continued to grow our footprint so that our managed and franchised revenues for the quarter were off only 5% compared to a worldwide system-wide RevPAR decline of 9%.

As projected, we added a record 87 hotels with 21,000 rooms in the year. Even after regressive pruning our Sheraton and LeMeridien portfolios, we enjoyed 4% net growth in rooms in 2008 and full year fee growth of 5%.

Our vacation ownership business did slightly better than expected during the quarter, a testament to our strong brands and world-class salesforce. We also benefited from aggressive cost savings to resize the business. And looking forward we will continue to focus on key, high return markets and to reduce our balance sheet exposure and be very selective in allocating capital to this business. This capital restraint is reflected in the write downs this quarter for land and vacation ownership projects that we’ve chosen to stop developing.

With the fourth quarter behind us, let’s turn now to our baseline scenario for 2009. A look back on 2008 underscores how difficult it is to forecast accurately lodging demand and RevPAR during these volatile times. The turbulent economy makes it nearly impossible to have a clear view on 2009. One of the few things we can say, though, with some confidence is that the precipitous drop in RevPAR in the fall of 2008 will make comparisons easier by the time we get to the fourth quarter of 2009.

In the face of this volatility, we’ve worked hard on what we can control, our costs and our capital. As mentioned above, our cost cutting will enable us to deliver higher EBITDA at lower RevPAR levels. So to set our baseline scenario, we looked at recent global RevPAR trends in 2009 booking pace. We also looked at two-year trend lines. And finally we used 9/11 for comparison purposes, when RevPAR fell by 15% over a four quarter period and occupancies fell almost 600 basis points.

On that basis, we set our baseline for worldwide RevPAR minus 12% and worldwide owned RevPAR at negative 15%. This would result in EBITDA of $875 million and EPS or $1.12. As you plan your own scenarios, let me remind you that every 1% in worldwide RevPAR is equal to about $20 to $25 million in EBITDA.

Given this cautious outlook, we’ve also dramatically scaled back our capital spending for 2008 in all aspects of our business, from vacation ownership to hotels and corporate infrastructure. This should allow us to generate free cash flow in 2009 and reduce our debt during the year. Vasant will take you through some of these numbers in more detail, including some specific areas where we’ll reduce our capital spending in 2009.

This brings me to the third topic, more detail on our approach towards reducing our costs. In anticipation of difficult times, we began last April to look at three areas, corporate overhead, property level operations and procurement. These efforts were largely implemented during the third and fourth quarters and generated substantial savings as evidenced by our quarterly results. As we described in previous calls, our efforts to reduce corporate overhead addressed immediate savings, as well as making lasting changes in our ways of doing business.

We used the activity value analysis process, or AVA as a vigorous way to address our costs and lay the foundation for future growth. The net result is that we will reduce our 2009 SG&A by roughly $85 million from 2007 levels. This includes only those savings already implemented. The AVA eliminated costs by streamlining activities and eliminating overlaps in our organization.

And to see why this was needed, it’s worth remembering that Starwood came together in the late 1990’s as a patchwork of organizations. A small lodging REIT acquired Westin, ITT Sheraton, the [Santa] and most recently Le Meridien. This resulted in a large organization with multiple offices and duplicate functions. To be sure, Starwood has performed well in spite of its complex structure. Nonetheless, we saw an opportunity to save money and be more agile.

Equally important, we wanted to structure corporate to better support our properties and owners. For example, the AVA process eliminated about 100 positions in our North American division overhead alone. But as we went through the process, we were focused not only on cutting costs but identifying how we better could meet the needs of our owners. This resulted in reorganizing some parts of our owner relations team, improved communication and support.

In light of Starwood’s past, we were not surprised that many activities could be centralized, such as a single service center for HR, consolidating AP and payroll, and centralizing legal functions. We also better aligned our development, architecture and design, and hotel opening teams to streamline the process from signing a contract to opening a hotel. And finally, we meaningfully expanded spans of control. In total, the AVA process has generated a 30% reduction in personnel costs across many of our corporate and divisional functions.

And at SVO we were able to reduce G&A by 45% and eliminate 35% of our salesforce. Alongside the AVA, another aspect of our overhead cost reduction efforts focused on compensation. This included benchmarking most positions, allowing us to [re-van] jobs and make sweeping changes in our equity compensation. And like many companies, we also froze salaries for 2009.

So to summarize, the cost reductions we’ve completed so far will save Starwood about

$85 million from 2007 levels. As a reminder, we realized substantial savings already in the back half of 2008, so the year-over-year reduction in 2009 SG&A is estimated to be $50 million. While the bulk of the AVA is behind us, we’re still exploring cost savings in some functional areas. Upon completion, we estimate our annual run rate savings to be over $100 million, which implies declining SG&A again in 2010.

The second area of our cost cutting focused on the property level, and we have two initiatives underway to do that. One is bottom up, and the other is top down. Between them we should be able to offset inflationary pressures, significantly helping our P&L in 2009. And to be clear, this is before the impact of any variable cost savings associated with lower occupancy.

Our bottom up approach is called Lean Operations, and it includes using our talent onsite to reduce work and waste. And just to give you a sense of detail, here are a couple of examples. We refined our staffing model to match work to demand. We also outsourced bakers and butchers. And we expanded spans of control for managers and supervisors. The Lean Operations team is working closely with our six sigma teams to implement these productivity enhancements across our hotels.

Our top down approach is called Normative Modeling, which analytically normalizes hotel cost performance based on structural variables such as size, configuration, number of service elevators, and unionization. Normalizing assists us in identifying top performing hotels and performance gaps. And as with Lean Operations, best practices are then rolled out across the system. Examples of this included reducing the number of housekeepers per occupied room and simplifying food and beverage concepts.

We’re also working with our owners to share these savings across our management franchise hotels. Equally important to our owners, we’re working hard to reduce our overall fees. This includes reducing categories of fees for what we charge. Taking for example training, Starwood has made great inroads for our brands with something called Service Culture Training. But the feedback from the properties is we reached a level providing too much of a good thing, so we’re cutting back on some of these efforts which will have an impact on the fees charged.

And finally, procurement is the third area where we’re reducing costs. These efforts are focused on introducing more categories to our buying programs, vendor consolidation, SKU rationalization and improved compliance. This has resulted in the ability to negotiate better contract terms. A few examples include reducing the SKU’s of food items and renegotiating contracts for laptops and flat screen TV’s. Given the success of our recent negotiations, we anticipate additional direct savings of $35 million in 2009.

So before I move on to my fourth and final topic, I want to thank our associates for their efforts in 2008. Despite cutting our costs dramatically, enduring the additional workload of the AVA process, and living through a challenging demand environment, we were able to increase our guest satisfaction and service scores across the board in 2008. Our Aloft and Element hotels enjoyed GSI debuts with scores usually reserved for successful luxury brands. Great service, satisfied guests, and strong brands are our best foundation for future success.

So I can’t over-emphasize what an amazing accomplishment this was for our team of associates, and it bodes well for our ability to own the upswing when the crisis finally subsides.

So let me turn now to our fourth and final topic, our long term vision for Starwood. In short, we remain committed to the direction we articulated in our previous calls. This strategy is what we call the Starwood Journey, driven through building strong brands, delivering brilliant execution, growing globally, all made possible by having great talent. We also continue to believe in our ability to generate great returns.

While the current environment has created intense pressure for us to manage costs, once the capital markets return we will once again continue our focus on the transformation to an asset-like model. In previous calls, we described the branded global hotel fee business as one of the most attractive business models in the capitalist world. The contracts are stable, capital efficient and long term.

Geometric fee growth is driven by three factors; RevPAR growth, unit additions and incentive escalations. We’ve already made substantial progress over the past few years in growing our managed and franchised business and reducing the size of our own portfolio. Today, 53% of our EBITDA contribution is fee income, up from 18% five years ago. Our goal over the long term is to be over 80% fee driven.

By itself, this focus on the fee business will result in a sustainable growth engine that throws off significant free cash flow. At the same time, our balance sheet holds more opportunities to generate cash in the form of owned real estate that are hotels and the vacation ownership business. We own or lease 69 high-end properties around the world, with great brands, located primarily in high barrier to entry markets.

These assets generate roughly 33% of EBITDA contribution and our JV earnings from minority interests has generated another 4%. While the asset disposition process has slowed dramatically for now, we closed on a $305 million asset sale during the fourth quarter and are in the process of testing the market for an additional asset sales. Reducing the size of our own portfolio will allow us to unlock the value for our shareholders through the sale proceeds. And remember, we can also benefit from our capitalized carry forward.

In 2008, our timeshare division accounted for roughly 10% of our EBITDA contribution. We’ve calibrated SVO to respond to the challenges of weak customer demand, high construction costs, and the lack of a securitization market. This right-sizing includes significant cuts to G&A, cutting our capital plans for 2009 and positioning this business to be a cash generator.

Reducing the size of our own portfolio in vacation ownership business will take time. These initiatives, combined with the growth in our managed and franchised business will result in a truly asset light, capital efficient business model. This will eventually reduce the need for the sum of the parts valuation analysis, like the one we provided in the last call.

So to summarize, we performed well in the fourth quarter despite a horrendous business environment and we’re prepared for continuing challenged times. Our early action in cutting costs should position us well through this downturn to maintain a low cost structure. We remain focused on our long-term strategy and remain committed to an asset light business model.

I started this call with a cautious, if not dim view of the coming year. And the press tends to make popular the view that this economic crisis is unique and unprecedented, which it is. But the same could have been said and was said for many crises in the past as well. I want to end by reminding you all of why I think Starwood is a great place to be as an associate, an investor or an owner.

I spent much of my career working and traveling around the world, and as I look back over the past 25 years and the transformation in places like China, India, Vietnam, Turkey, Central Europe, the Middle East, Africa and Latin America, I’m startled both by how far they’ve come and by how much more they still have to grow. Fundamentally, the global economy will rebound. The inevitable forces of globalization, capital flows, emerging middle class and the demand for travel infrastructure including hotels will return.

Today’s reduced travel budgets and vacations are tomorrow’s pent-up demand. When the turnaround happens, we will be in a position once again to leverage our great brands, our unique properties and our truly global organization to make the most of this opportunity. It’s up to us to respond to the current environment, but not to compromise its ability to grow.

So with that, I’d like to turn the call over to Vasant for more details on our fourth quarter results and thoughts for 2009. Vasant.

Vasant M. Prabhu

Thank you Frits and good morning everyone. Over the next few minutes, I will provide some color on business conditions worldwide so far in January; how we are approaching 2009; and then move to capital, cash flow and balance sheet management.

As Frits mentioned, the hotel industry recession is now global in scope and much deeper than we might have expected in mid-October. For the first three weeks of January, company operated RevPAR in North America is down 22% and owned RevPAR which is concentrated in major metro, resort locations and luxury hotels is down even more at 27%. In Continental Europe, trends are similar, with dollar RevPAR down 20%, 13% in local currency at company-operated hotels.

In Asia, RevPAR declined 17% and after staying positive through most of the fourth quarter, Latin American RevPAR dropped sharply in December and is trending down 10% so far in January. The Middle East a bright spot through 2008 has been hit hard by the war in Gaza and the collapse of oil prices, declining 5% in January. And all the indications are that these trends will not improve through the first quarter.

In our vacation ownership business, which has been experiencing significant decline for several quarters, we saw some stabilization of trends in Q4, which appears to be continuing into 2009.

Looking ahead at some leading indicators, in North America growth pace for 2009 at company operated hotels is down 13%. Cancellations are up. The number of meetings and attendees are down. Over 70% of corporate [written] negotiations are now complete. Rent achieved is roughly flat to last year. With retail rates still tracking materially above corporate negotiated rates, we expect rate realization to be at contracted levels.

On the transient side, as may be expected, retail business is down significantly and has been replaced by other transient segments but at a lower realized rate. And booking windows are much shorter, making future projections even harder. There appears to be significant hesitation among travel decision makers to make commitments while they wait for their own budgets to be defined, and as they monitor the impact of the recession and the actions coming out of government on their own businesses.

As such we see a lot of pent-up demand which could come into the market at some point, but it is hard to predict exactly when. The environment is fast changing and very uncertain. As Frits described our approach has been to focus hard on the two major levers we can pull, cost and capital, and pull them hard. Cutting is deeply into both cost and capital without compromising the integrity of our brand and our growth potential.

On the revenue side, our revenue management and sales efforts are geared toward us gaining share and capturing as much of the available revenue as we can. At owned hotels, our baseline scenario anticipates RevPAR declines of 15% in North America and globally. Of course there are many ways in which you can expect 2009 to unfold by quarter. In rough terms, you can get to a 15% RevPAR decline for the year starting with a 25% decline in Q1, down 20% in Q2 and moderating to minus 13% and flat as we lack the minus 20% we experienced in Q4.

In addition, the negative impact of foreign exchange moderates as we lack the stronger dollar in the second half, especially in the fourth quarter. On a two-year run rate basis, this implies RevPAR will be 10 to 15% below 2000 in levels all the way through 2009. Given the magnitude of these declines, we are going well beyond the original contingency plan undertaken at times like these to fundamentally rethink our hotel operating practices, to run hotels leaner than we ever have.

Frits described some of the initiatives underway. While margins at owned hotels will decline significantly due to the sharp RevPAR drop, these actions will mitigate margins lost. The impact of all these actions is incorporated in our baseline scenario. With worldwide owned hotel RevPAR declining 15%, EBITDA declined 35% implying a flow through of around 50%.

For all company operated hotels the baseline scenario we’re using for internal planning purposes assumes a decline of 12% globally or 9% in constant dollars. The decline in RevPAR in managed franchised hotels is expected to be lower for a variety of reasons. Our geographically diversified footprint includes parts of Asia, the Middle East and Africa which are holding up relatively better. It is not as concentrated in a few major global metros as our top 40 owned hotels are.

We benefit from the 150 hotels we opened in 2007 and 2008 that are ramping up, as well as a large number of hotels coming out of renovations. Helped by new hotel openings, key revenues will be more resilient, declining 10% in our baseline scenario. This baseline is based on both bottoms up hotel budgeting and our own top down assessments of all available data.

Given the nature of our business, even in the best of times it is hard to project four quarter results with any level of certainty, let alone at a time like this. Our baseline expectations assumes RevPAR decline moderates in the second half as we lack weaker quarters from 2008 and the strengthening dollar, which adds 200 basis points to second half dollar RevPAR. We have other planning for actions we will take if this expectation for the second half does not play out.

We opened 87 hotels in 2008, 58 in the U.S. including 7 aloft and 29 hotels internationally including 7 in China. We expect to open 80 to 100 hotels in 2009. Our pipeline remains robust at 425 hotels or 100,000 rooms. Given the credit crunch underway, the pace of new deals coming in has significantly declined. Financing issues are slowing down many deals and in some cases deals have been put on hold as developers seek to resolve financial issues. We have adjusted our 2009 openings expectations and our pipeline based on the best available data.

In our vacation ownership business, as I mentioned earlier, after several quarters of decline store flow, close rates and pricing appeared to stabilize in Q4. Our baseline scenario assumes that Q4 trends hold through 2009 with some seasonal adjustments. Vacation ownership profits dropped

$50 million. Should trends lessen, we will look to further resize our vacation ownership infrastructure.

With the cost reductions, our SG&A will decline $50 million from a baseline EBITDA of

$75 million or $1.10 per share. For each point RevPAR is different than our baseline, EBITDA will be up or down $20 to $25 million.

With regard to the impact of exchange rates on our reported earnings we have hedged about half our euro exposure above $1.50. If the euro stays at current levels, our effective rate for 2009 will be around $1.45, not very different than our effective rate of $1.47 in 2008. So we are less susceptible to moves in the euro, our largest non-U.S. currency.

We’re also partially hedged on the Canadian dollar and un-hedged elsewhere. We have some natural hedging between some currencies such as the yen and the [Aussie] dollar. And we will continue to monitor currencies to determine if any additional hedging is warranted. Of course hedging does not help reported RevPARs, only reported earnings.

Moving on to capital, cash flow and balance sheet items, our approach to capital is spend only what we have to. Inside projects that cannot be stopped or slowed down, essential maintenance capital at owned hotels and no new projects initiated in our vacation ownership business. We have a few renovations and expansion projects at hotels that we are completing. They’re finishing up construction of a few SVO projects that are close to completion or pre-sold.

We have reviewed all projects under development at SVO and decided that we will no longer pursue several projects. In all cases we have written off development costs incurred to date. And in the case of two locations where we own land, one in the Caribbean and the other in Mexico, we have written down carrying value to our best estimate of market value.

We will continue to monitor the SVO portfolio to determine if further actions are needed. As a result of these actions our capital spending will be down significantly from 2008. Hotel maintenance and IT capital spending has been cut in half to $150 million. SVO will be cash positive. In other words, our capital spend will be lower than inventory sold.

In [flight] investment projects underway at hotels, which we will complete, key money and joint venture commitments we have made and our project in [Bell] Harbor will require another

$175 million in net capital. As Frits indicated we remain at Starwood Hotels. Based on volume of sales, we look forward to better market conditions and values achievable. We are not including any proceeds from asset sales in our projections for 2009.

We did receive over $300 million from sales that closed in Q4 and all this cash has been repatriated to the U.S. with no tax leakage. We are constantly monitoring the market for vacation ownership receivables. We have approximately 500 million receivables available for sale. While conditions have improved somewhat, the market remains stressed. As such we are not projecting the sale of receivables in 2009. However, it remains our clear intent to sell as much as we can and we will update you as we know more.

In January as we reached a settlement with the IRS on longstanding litigation, also known as the World Directories Case, all taxes have been paid. But based on the settlement, we will receive a refund of over $200 million after we finalize the agreement, most likely late in the second quarter.

Our gross debt in Q4 was slightly over $4 billion. Net debt was around $3.5 billion, lower than Q3 due to cash from asset sales. At the end of the year we had $300 million in cash, over and above our normal working capital cash needs. Q1 is our peak quarter for cash use with the annual dividend payment and other cash needs. We will draw down the cash on our balance sheet to meet these needs and expect gross debt levels to remain relatively unchanged at the end of Q1, just as Q4 2008.

With our baseline EBITDA, the capital plans outlined and cash from the tax refund, our gross debt level will decline in Q2 to $3.8 billion and end the year around $3.6 billion before any asset sales or receivable securitizations. With all the actions we are taking we expect to remain in compliance with our bank covenants through 2008.

We have a bank debt loan maturing in June. We will most likely use our revolver to pay it down. We will of course explore all other options, including a bond issue if market conditions improve and discuss terming out the loan with our bank. We remain in close touch with all our banks, monitoring conditions both in the bond and the bank markets.

It has been our practice to be proactive and maintain as much balance sheet flexibility as we can. To that end, in conjunction with exploring options for our maturing term loans, we will also evaluate with our bank group the cost benefit of terming out our revolver, which matures in 2011, earlier than usual and getting more flexibility on covenants. Market conditions will determine what we decide to do.

We paid out our 2008 dividend of $0.90 per share in early January. Based on 2008 EPS, excluding special items of $2.19, the pay out ratio worked out to 41%. [Inaudible] our payout ratio has ranged from 25 to 40%. Based on our baseline EPS of $1.10 in 2009, a $0.90 dividend would work out to a payout ratio 80%. As such it is unlikely that we will maintain our dividend at a $0.90 level. If we maintain a payout ratio in the 25 to 40% range, it will result in significant dividend reductions.

Given the substantial change in market conditions, we are reviewing our dividend plans with our board and will update you as the year progresses. As you know it is our normal practice to announce our annual dividend in the fourth quarter each year.

So in summary, our objective in 2009 is to prepare for all eventualities that could materialize. We have cut deeply into our cost structure and will cut more if we have to. We have cut deeply into our capital spending and will continue to look for more opportunities. Our sales and revenue management programs will be geared to capturing as much share as we can of the revenue available. We will be exploring all avenues to raise cash from asset sales at reasonable prices to receivable sales on acceptable terms to getting our tax refund.

We will continue to stay close to our bank group and explore all options to maintain maximum balance sheet flexibility and liquidity. With that, I’ll turn this back to Jay.

Jason Koval

Thanks Vasant. We’d now like to open up the call to your questions so in the interest of time and fairness please limit yourselves to one question at a time and then we’ll take any follow-up questions we might have as time permits. Tamra, we’re ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Celeste Brown - Morgan Stanley.

Celeste Brown - Morgan Stanley

Frits this is a bigger picture question for you. I know you came in from another industry and you’ve said in the past you’ve said there’s a lot of opportunity to I guess shake up the company a little bit. You know, things have been done for the same way for a long time. Have you gone – have you been able to achieve everything you’ve wanted to do given the environment or are there further steps you can take and would you consider selling the SVO business? It sounded like you were suggesting it during your commentary. Thanks.

Frits van Paasschen

No, first of all we’ve obviously been very focused on achieving cost reductions and I think there’s really so much more we can do, especially around the area of innovation and growth. So I think there’s still a lot of opportunities for us in the big picture. Having said that just to respond specifically to your question about SVO, no we have no intention of selling that business. We believe it has a sensible place in our business. It’s just really a question of size and specific return opportunities as we look at projects across geographies.

Jason Koval

Next question please.

Operator

Your next question comes from Joseph Greff - J.P. Morgan.

Joseph Greff - J.P. Morgan

I thought one of the takeaways from today’s release and your commentary this morning on the call is the good job that you’re doing in taking out costs from SG&A. And I guess the way to characterize it is in the ’09 baseline outlook for SG&A you’re just reflecting the cost cuts that have been implemented to date. That implies to me that there is more costs to come out. Is it possible that you actually achieve some of those in ’09? I guess maybe can you quantify that and maybe you can just talk about that a little bit.

Vasant M Prabhu

Joe, yes we have some more cuts coming. We were planning to finish most of our AVA that Frits described in the SG&A area in the first quarter. Those are incorporated in our expectations. I think what we would look to do is if the second half looks worse than we might expect at this point, you know, we clearly are looking at what else we would do under those circumstances. Would we look to, you know, further downsize? Yes we would, both in the hotel side as well as the vacation ownership side.

But in terms of the programmatic cuts, we tried to incorporate as many of those as we can in the baseline we provided.

Frits van Paasschen

But just to be clear, the reason that we said that not all those – that we’re still implementing some of those is that they’ll be in place towards the back half of 2009, so 2010 would be lower as we get the full year benefit of those reductions we’re currently making.

Jason Koval

Next question please.

Operator

Your next question comes from David Katz - Oppenheimer & Co.

David Katz - Oppenheimer & Co.

You know, we’ve talked with a lot of different hotel operators all week with a conference in California about the negative flow-through on RevPAR declines. And you know I think generally speaking people felt like a we saw in your own portfolio down 15% equals about a 35% decline in EBITDA. What kind of negative flow-through are you getting or expecting to get on your franchise business and on your management business?

Vasant M Prabhu

David, on the franchise side of course we don’t run those hotels. You know we make available to them all the programs that we do in our own hotels to the extent that we can. We would attempt to do in our managed hotels much the same that we do in our own hotels. They’re clearly very focused on getting them done in our own hotels as a place to validate all the programs, but we are moving fast to do the same things in our managed hotels. And the main goal of the programs is not just to lower variable costs but really to see how you can lower the fixed cost structure.

Jason Koval

Next question please.

Operator

Your next question comes from Felicia Hendrix - Barclays Capital.

Felicia Hendrix - Barclays Capital

I just wanted to talk about your unit growth expectations. Just how can we expect or how do you expect or how should we look at this for the pipeline to evolve in this environment, just given the difficult financing environment that we’re in?

Frits van Paasschen

I think the critical variables here are three. One is the rate of signing and as Vasant referred to in some of his text it looks clear that the rate for signing will go down in this environment. The second is, those hotels that are signed and whether they come to fruition and I think that yield rate will go down, and that’s reflected in our shift from 470 in the last call to 425 now. And then finally there are the hotels that are about to be opened. And you know particularly as we look forward to 2009, those projects are so far along now that while we expect some may have some difficulty, the large majority of those will come to fruition.

Jason Koval

Next question please.

Operator

Your next question comes from [David Low] – Robert W. Baird.

David Low – Robert W. Baird

Vasant, I want to ask about the leverage test, specifically if you could just talk a little bit definitions in that covenant. For example, do impairment severance and other special items count towards – count against EBITDA when calculating that? And what’s your preferred method of reducing gross debt? Would it be buying in bonds or would it be paying off term loan or paying off a loan?

Vasant M Prabhu

Yes, there are two tests. Everything by the way is available in our bank agreement which I believe is publicly available, right? So you can read it for yourself if you’d like to. Quickly summarizing there are two tests, there’s coverage and there’s leverage. The coverage test there’s plenty of room. On the leverage test is the one that we are watching closely of course, based on a last 12 months basis, so it’s rolling four quarters for the previous four quarters. It’s based on EBITDA divided by gross debt.

Gross debt is pretty much the gross debt you see on the balance sheet. The adjustments are minor. In terms of EBITDA it’s the reported EBITDA not counting one time items except for adjustments for cash portion of restructuring costs. And some minor adjustments which levee interest. So those are the adjustments. And of course we are monitoring both the EBITDA levels as well as what ever adjustments would be made to that.

In terms of our preference for debt management, you know, we always look at the pros and cons of buying back bonds. But our approach so far has essentially been to lower our overall debt, debt levels because we’ve had out standings on our revolver which has come down. We have a debt maturing in June. You know, we may term out some parts of it. We’ll take the rest of it down on a revolver which will give us an opportunity to pay down some more debt from that. So we’ll look at all options.

Jason Koval

Next question please.

Operator

Your next question comes from Patrick Schools - Friedman, Billings, Ramsey & Co.

Patrick Schools - Friedman, Billings, Ramsey & Co.

On your fourth quarter results, it looks like your incentive management fees held in there a little bit better, down about 6% than I would have expected given the double-digit RevPAR declines. What are your expectations in the first quarter of ’09 and then for the remainder of the year as far as incentive management fees, given your RevPAR outlook?

Vasant M Prabhu

Yes, the reason they held up reasonably well is we spent 85% of our incentive management fees on non-U.S. So they don’t have the same susceptibility. A, they’re not as exposed to the U.S. alone. They’re better geographically diversified. But second is because there’s no preferred return concept in the non-U.S. fees they don’t tend to have as deep a slope, both in the up and the down, which is why we don’t think, unlike some of the other people you might look at, our incentive management fees won’t quite behave the same way.

Our contracts in the U.S. don’t pay much in terms of incentive fees. Incentive fees in the U.S. are less than 15%. That’s because many of them are new and you know you normally get into incentive fees when there’s a preferred return later in the sort of the life of a contract. So we would expect similar behavior to continue. Of course, when it comes to the fact that 85% of your incentive fees are non-U.S. you have exchange rate effects also, so we just have to make sure you incorporate that.

Jason Koval

Next question please.

Operator

Your next question comes from Swedes Rose - Keefe, Brunette & Woods.

Swedes Rose - Keefe, Brunette & Woods

It looks like you cut the retained residual interest in the timeshare notes almost by half from the third quarter. Are higher defaults driving that? And then can you also just answer how many employees are left in the timeshare business, if you’ve laid off 900 so far.

Vasant M Prabhu

Yes, I’ll answer the first question but on the second I don’t believe we have the data available here, do we? No, I don’t think so. On the first you know the return interest has to be valued based on two major factors, default rates as well as discount rates.

The biggest factor affecting the bad carrying value was we substantially widened the spread value for the discount rate based on where market conditions are. So we’re discounting at a much higher rate than we have in the past. I believe a lot of these details will be in our 10-K so you’ll be able to see precisely what we did. Default rates are also up, but not dramatically. They’re still in the 5 to 6% range, but the far larger driver was the discount rate and what we’ve seen in spread.

Something here to decide is which we debated a lot is sort of how much of this is transitory and should we really widen our spreads that much and concluded that we would. And assume that this is going to stay this way for awhile.

Frits van Paasschen

Just a – without giving you an absolute number on the SVO side it was approximately a 40% reduction in headcount of all employees who were not on property. So of the G&A and the sales organization it was about 40% of the total number of associates.

Jason Koval

Next question please.

Operator

Your next question comes from Chris Corona - Deutsche Bank Securities.

Chris Corona - Deutsche Bank Securities

Just thinking about how maybe the current economic environment and credit markets might impact your plans for Sheraton. I mean we know that you’ve been a little bit more flexible working with some of the owners on a temporary basis. How do you see that playing out as you continue to try to revitalize the brand?

Frits van Paasschen

So Chris as you know we – our approach to revitalizing the Sheraton brand is really focused on three areas. One was the opening of new Sheraton hotels and over the time period from ’07 through ’09 I think the number was about 25 or 26 we planned to open. Of those that are still to open, we feel good about them again because they’re so far down and so far along in the process.

In terms of – another part of that was just actually pulling hotels out of the system. And we continue to do that aggressively and if anything the opportunity costs of lost EBITDA from doing that is even lower. And then finally, more directly to the question you asked which is there were about 100 renovations in the process over that three-year period.

And once again most of those are far enough along that we see them going to completion. One of the things that we are doing in some cases is looking at whether we wait with a few aspects of that, but generally it’s doing most of the process by the time we get to the end of ’09. So we should be pretty well on track even in the current environment.

Jason Koval

Next question please.

Operator

Your next question comes from William Marks - JMP Securities.

William Marks - JMP Securities

Regarding the RevPAR outlook, can you number one give us a sense of occupancy versus ADR? And number two, if there’s any kind of breakdown by brand, particularly Sheraton, Westin – should one do better or worse than that average?

Vasant M Prabhu

I don’t think we can give you a breakdown by brand. And so much of what happens by brand is a function of footprint. You know, where the hotels are, not just in the U.S. but also on a global basis. And your first question was occupancy versus rates, I mean you saw what the mix was in

Q4 about 60% occupancy, 40% rate. You know that sort of thinking it’ll be somewhere around 50/50 or swinging a little bit more towards rate as it typically does as it cycles through the – so you should assume somewhere in that range.

Jason Koval

Next question please.

Operator

Your next question comes from William Truelove – UBS.

William Truelove – UBS

I’ve got to ask my obligatory timeshare question. The build out time period on your Page 17, you’ve got 374 units on pre-sales of development and another call it 2,200 in future capacity, so what’s the commitment level to the future capacity level of development and what is the eventual build-out time if you don’t do anymore new projects as you’ve indicated? Thanks.

Frits van Paasschen

Well, to go to the first part of your question first, our view is we are going to look both on a by geography as well as a by phase basis, so even in a given location we can decide whether we move to the next phase based on our anticipated return. So the 2,200 capacity is what’s available, should we decide to move forward with all of that. But you know as I think we’ve indicated in both of our discussions earlier, we remain very much – we reserve the right to be selective about which ones we move forward on.

Jason Koval

Next question please.

Operator

Your next question comes from Celeste Brown - Morgan Stanley.

Celeste Brown - Morgan Stanley

First I was hoping you could help us think a little bit more about the SG&A progression given that you reduced so much in the fourth quarter, but you have a lot of seasonality. Just help us think about it through the four quarters of 2009. Thanks.

Frits van Paasschen

I don’t think we broke it out how we wanted or haven’t communicated exactly how that’s going to break out over the quarters. We were able to do is take a lot of the decisions pretty early in the AVA process and obviously we sequenced that process to try to realize as much as early as we can. And so I think the way to think about what is left is to imagine that getting phased out over the course of the year. Also another aspect of that is there are ideas and initiatives to save money that we moved forward on in December that themselves will take awhile to implement.

Jason Koval

Next question please.

Operator

Your next question comes from Felicia Hendrix - Barclays Capital.

Felicia Hendrix - Barclays Capital

Just on your timeshare projects that you talked about stopping some that were already underway. I don’t believe you’ve said which ones and I’m hopping between two calls. If you did, I apologize, but I was wondering which ones were going to be stopped?

Vasant M Prabhu

What we said was that we looked at all our projects, there were a few that were in very early stages that we’ve decided we will not pursue and have written off all costs incurred to debt. There were two in particular. We identified them as one in the Caribbean and one in Mexico that we already owned the land and we had incurred all the costs associated with getting the usual permits, all the thought processes associated with design, etc., some construction of sales centers and all that was complete.

The actual construction of timeshare units hadn’t really started. We decided we would not proceed with those based on our assessment of returns. So those are the ones that we wrote off, everything that was incurred to debt, and wrote down the land to our best estimate of market value. And those would be one in the Caribbean and one in Mexico.

Jason Koval

Next question please.

Operator

Your next question comes from David Katz - Oppenheimer & Co.

David Katz - Oppenheimer & Co.

I’m not sure if this was covered already, but one of the items in the quarter was I think a

$22 million write-down on some timeshare notes that had already been securitized. How did – am I reading that correctly? And how did the mechanics to that, how did that work?

Vasant M Prabhu

Yes, we have something –

Frits van Paasschen

David we did actually answer that earlier, so I can give you a ring afterwards if you’d like to follow up.

David Katz - Oppenheimer & Co.

Sure.

Frits van Paasschen

Okay.

Jason Koval

Next question please.

Operator

Your next question comes from Michael Stone – dealReporter.

Michael Stone – dealReporter

Can you guys give any color on what types of assets you’d sell, specifically what characteristics in an asset qualify for your internal lists for something you’d consider selling?

Frits van Paasschen

Sure, Michael. Could you identify your organization for us?

Michael Stone – dealReporter

Sure. It’s dealReporter, it’s a part of the Financial Times group.

Vasant M Prabhu

Okay. I’m sorry. Would you please repeat the question?

Michael Stone – dealReporter

Sure thing. I’m just wondering if you could provide any color on what types of assets you’d consider selling. Specifically which characteristics of an asset would make it qualify for your internal list?

Vasant M Prabhu

Yes, we’ve never really talked publicly about which specific hotels are for sale. I think we’ve said for a while and then again today that our goal has always been to be lighter on owned hotels. But we’ve never really ever publicly stated you know X number of hotels or these specific hotels are for sale right now.

Jason Koval

Operator, are there any additional questions?

Operator

There are no further questions at this time. I would like to turn the call back over to Jason Koval for any additional or closing remarks.

Jason Koval

All right. Thanks Tamra. That wraps up today’s fourth quarter call. We appreciate your time and interest in Starwood Hotels and Resorts. Please feel free to reach out to any of us for any other questions that you might have. Good bye.

Operator

Ladies and gentlemen that does conclude today’s conference. We appreciate your participation. You may disconnect at this time.

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Source: Starwood Hotels & Resorts Worldwide Inc. Q4 2008 Earnings Call Transcript
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