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

Q2 2009 Earnings Call Transcript

July 23, 2009 10:30 am ET

Executives

Jason Koval – Investor Relations

Frits van Paasschen – President and Chief Executive Officer

Vasant Prabhu – Executive Vice President and Chief Financial Officer

Analysts

Joe Greff – J.P. Morgan

David Katz – Oppenheimer

Steven Kent – Goldman Sachs

Felicia Hendrix – Barclays Capital

David Loeb – Baird

Janet Brashear – Sanford Bernstein

Bill Crow – Raymond James

Jeff Donnelly – Wells Fargo Securities

Ryan Meliker – Morgan Stanley

Chris Woronka – Deutsche Bank

Will Marks – JMP Securities

Patrick Scholes – FBR Capital Markets

William Truelove – UBS

Operator

Good day and welcome to the Starwood Hotels second quarter 2009 earnings conference call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Mr. Jason Koval, Vice President of Investor Relations. Please go ahead, sir.

Jason Koval

Thank you, Tamara, and good morning, everyone. Thanks for joining us this morning for Starwood’s second quarter 2009 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, foresees, 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 as of any other subsequent date. Actual results might differ from our discussion 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'm pleased to turn the call over to Frits for his comments. Frits?

Frits van Paasschen

Thank you, Jay. And thanks for joining today for our second quarter call. As you saw in our release this morning, the second quarter’s RevPAR results paint a picture similar to the first quarter. The free fall in RevPAR has abated and occupancy has been stable for about three months now. Rates, however, continue to remain under pressure for the coming quarters.

Our view is that the stability we are seeing now is not the same as a genuine economic recovery. When recovery arrives, it will be challenged as business and consumer confidence, the investment environment and capital markets adapt to further deleveraging. Whether you call it the new normal or the reset economy, there is a lot of uncertainty about how and when the recovery will unfold. So for internal purposes, we continue to plan based on a range of scenarios for the future.

With that in mind, I want to start by summarizing how we improved our liquidity by nearly $1 billion in the last few months. We amended our credit agreement, issued $500 million of bonds at attractive rates, and completed $125 million securitization. We also executed two transactions that were not in our original debt reduction plans. First, we extended a co-branded credit card partnership with American Express and received $250 million. Second, we announced the sale of the W San Francisco for $90 million. All told, these measures significantly reduced our total debt and put us on a path towards returning to an investment grade rating.

Vasant will share more thoughts with you on our liquidity and leverage. I’d like to focus my comments today on three main topics. First, a review of our second quarter results; second, an update on cost-cutting and capital containment efforts; and third, a look at how we are investing in our brands to reinforce our position as the premier innovator and brand builder in the lodging industry.

So let’s start with the first topic, a quick review of our second quarter results. This was the third quarter in a row where controlling cost enabled us to beat EBITDA and EPS expectations despite a $10 million EBITDA hit from H1N1. Efforts to reduce costs have been pervasive throughout Starwood and reflect hard work and discipline from so many of our associates at our properties and at our corporate offices.

Worldwide, system-wide RevPAR dropped 24%, and worldwide owned hotels saw 30% decline in constant dollars. As mentioned on our last call, Starwood’s traditional strength continue to be headwinds in this environment. Our global footprint means that FX comparison has dragged our earnings down and so did our high-end hotels in New York, Hawaii and Italy. To that point, luxury RevPAR for the first half of 2009 was down almost 30%. That’s 500 basis points worse than after 9/11.

By comparison, our fee business held up pretty well, with revenues down only 18%. Unit additions and ramping fees from the nearly 250 hotels opened since 2006 helped to offset RevPAR declines. Today we expect to open towards the low end of our range of 80 to 100 hotels during 2009.

Our reported pipeline now stands at 90,000 rooms. We pulled 25 deals from the pipeline based on financing issues experienced by our owners. We signed 20 new hotels and opened 16. From our global vantage point, we see growth in markets such as Asia-Pacific, Africa and the Middle East. In fact, over two-thirds of the rooms slated to open are outside of the US.

In vacation ownership, our aggressive rightsizing allowed us to drive EBITDA of $28 million for the quarter. This is only 20% below last year despite a 47% drop in originated sales. We have not reduced prices, though a shift in mix drove down realized average price. And just as with hotel occupancy, the free fall was over. Tour flows and close rates have stabilized over the past six months. Hawaii has shown modest improvement from depressed levels.

As mentioned on our previous call, we reduced SVO’s overhead by 45% and our sales force by 35%. This resizing will continue as we adapt the business to the new reality. And we continue to pull cash out of the business by monetizing existing inventory. With our recent securitization, we expect to generate over $150 million in cash from vacation ownership this year. So in summary, despite the most challenging RevPAR environment our industry has ever faced, we continue to beat expectations through cost containment.

This leads me to my second topic, additional details on our cost-cutting initiatives and our approach to capital allocation. At the property level, it’s all about driving flow-through. I recently toured one of our hotels where our lean operations team has cut nearly 10% of controllable costs. This includes a variety of bottom up changed designed to make a permanent change in our cost structure. So for example, we are staffing to demand and increasing spans of control among hotel management. We’ve been able to boost productivity without comprising the guest experience. Our guest satisfaction scores have continued to rise.

And finally, after making dramatic changes to our overhead structure, we continue to prune our SG&A. Overall SG&A in our quarter was 30% below last year. The majority of these savings are sustainable with the exception of a few one-time items and a reduction in incentive comp for the year. We are still on track also to achieve overhead savings of over $100 million.

As I’ve said on previous calls, but it’s worth mentioning this again, our cost-cutting exercises were rolled out with care to ensure that we do not sacrifice future growth. We’ve maintained resources in regions where long-term growth and prosperity and infrastructure will continue, such as Asia, the Middle East and Africa.

We have also conserved resources in topline generating areas such as sales and revenue management. We also continue to look hard at capital projects. Company-wide capital spend dropped by nearly 60% from 2008 levels and we are focused on containing 2010 capital commitments as well, which leads me to Bal Harbour. As it stands today, we are evaluating our options for this project and expect to share definitive plans with you on our third quarter call.

So far throughout this call, we’ve been describing ways we’ve worked to bulletproof our income statement and our balance sheet in the face of extraordinary times. We want to make it clear that at the same time we remain committed to what has made Starwood a global success over the past decade; our innovation and our portfolio of distinctive and compelling brands.

I’d like to spend some time elaborating on this as my third topic for today. And to do that, I’ll outline our thinking about our brand portfolio, innovation and revitalization of Sheraton. In our portfolio, we have three terrific brands in each of the segments where we operate; luxury, upper upscale and select serve. This brand depth helps us with guests and developers alike. We can meet the needs of a guest who might choose the W for business trips, the St. Regis for an anniversary, for the Sheraton for a family getaway.

Our portfolio also creates a menu for developers, as they are often looking for a distinct brand in an economic package for a given project. Internally, we have realigned our brand organization around what we call individual spirit, collective strength. Put simply, we will invest in those areas that make each of our individual brands stand apart in the eyes of our guests, and at the same time, we will leverage a common platform to drive efficiency and purchasing power.

Continuing to build on our legacy of innovation, our plan design center in New York City will open later this year. It will house all of our design functions for our luxury and contemporary lifestyle brands, from online to graphics to architecture. Not only will the center be our connection to the best creative talent in the world, but we will also pool that talent to spark ideas for each of our brands and work together with developers.

Innovation lies at the core of who we are and how we set ourselves apart. We believe the brands are not just a guarantee of consistency. They are much more than that. Brands are an opportunity to establish emotional connections with our guests. And therefore innovation at Starwood means making big bets based on consumer insights to strengthen brand position. Take Westin, for example, the brand positioning is centered on renewal, which is reinforced by the Heavenly Bed and its extensions.

Innovation is about concentrating on a few aspects of the experience that can set a brand apart. So let’s talk about how this plays out for Sheraton. Rather than a bevy of new brand initiatives of Sheraton, we are focused on bringing the Link@Sheraton to 90% of our properties this year. The concept is so popular that it’s spawning further innovation for F&B with the Link Café.

Innovation is also about taking great ideas and making them available to guests all around the world. In fact, one great aspect of the lodging industry is the footprint growth actually strengthens our brands. This is unlike many luxury businesses where more points of distribution may undermine brand appeal.

So take W for example. Our biggest complaint from guests is, why aren’t there more of them. The fact is our business -- in our business, growth begets growth. A case in point is our W Maldives property that sees many guests from Seoul and Istanbul, which wouldn’t normally be feeder [ph] markets to the Maldives, except there are cities with an existing W hotel. It creates a network effect. And this network effect will go into overdrive in the US as we open W’s over the coming year in South Beach, Atlanta, Boston, Fort Lauderdale, Hoboken, Hollywood, Austin, New York downtown, not to mention Washington DC right across from Treasury.

This is also true, as we transform W from its New York roots into a global powerhouse through openings in Doha, Santiago, Barcelona, St. Petersburg, Guangzhou, Paris and London, not to mention resorts [ph], Bali and Koh Samui. All told, W’s footprint will more than double through 2011 to over 60 hotels worldwide. So while W may be a ten-year old innovation, we’ve refined the concept, improved the design and service delivery and are introducing the W experience for the first time to Europe, the Middle East and South America.

We’ve also leveraged our W innovation through the launch of aloft. We expect that aloft will turn the select serve segment on its head like W did to luxury. We are already seeing the kind of buzz, media attention and consumer interest that we did when we launched W. In fact, by year-end, 40 alofts will be open, a feat that took Marriott four years to achieve with Courtyard. And we are still building awareness through aloft, supported by scoring guest satisfaction scores from existing guests. And through a close dialog with owners, we are making sure that as aloft evolves, it becomes even more profitable and distinct from its competitors. And given the size of the select serve market, we have enormous growth potential for this innovative brand.

We are also using our innovative approach and our platform to make Le Méridien’s rebirth as a European contemporary lifestyle brand a reality, with art and design at the heart of its positioning. Renovations in Paris and Barcelona have led the way in bringing this new direction to life, as have new openings in Shanghai and Bangkok We also continue to prune and improve this portfolio to maintain and establish consistency.

Moving on to Sheraton, the brand revitalization in the US is right on schedule. By year-end, 90% of our rooms will be at or above brand standard. This is a huge change. In 2007, only about 50% of the rooms met that standard. And by the end of this year, we will have also removed 24 hotels that could not feasibly reach that standard. And 70 of the nearly 98 planned renovations for this year are now complete and the rest are on track.

I have already mentioned the Link@Sheraton will be 90% of our properties. The consumer response to this revitalization is remarkable. Guest surveys show likely to return and likely to recommend at all-time highs. The same is true with Meeting Planner Satisfaction. The revitalization of Sheraton in North America will enable it to reach its international standing. In China, for example, Sheraton is the most recognized four and five-star brand. It was introduced in Hong Kong in 1974 and was the first international hotel brand to open in the PRC in 1985. It’s no surprise then that Sheraton has the largest share of our Chinese pipeline.

And while I’m talking about China, it’s also worth mentioning that China just became our fourth largest national SPG market. With over 40 hotels in China today and another 59 under construction, China is soon to be our second largest hotel market after the US. So our SPG base will only grow there. Accordingly, we are adapting our offers in communication to Chinese guests, including the recent opening of our call center in Guangzhou. Looking forward, we plan to leverage that emotional connection to our brands as the Chinese increasingly travel abroad. Think back to the Japanese travel boom of the 1980s times ten.

So before I conclude, I should mention that we’ve attached a presentation on our corporate website that features each of these brands I’ve discussed today. And with that, I’d like to close by focusing on three key takeaways. First, we’ve accomplished in cost reductions what we set out to do more than a year ago. This enabled us to deliver strong earnings in the face of dismal demand environment. And the savings have permanently lowered our cost structure. The reductions have not compromised guest satisfaction or growth potential.

Second, we made real progress on the balance sheet objectives set forth earlier this year, including better liquidity and a less leveraged balance sheet. This positions us not only to survive the downturn, but to emerge stronger. And third, we have accomplished the first two goals without losing sight of our long-term growth trajectory. It all starts with great talent. This talent can deliver guest experiences that build our brands, enable global growth and generate strong returns. And despite these challenging times, we remain focused on doing what we do best, introducing game-changing innovation and bringing our brands to life through guest experiences that we create everyday around the world.

And with that, I’ll turn the call over to Vasant.

Vasant Prabhu

Thank you Frits. And good morning, everyone. I’ll start with a discussion of liquidity and leverage and then move on to a review of business conditions and our outlook for the balance of the year. On our last call, we told you we had initiated a broad range of initiatives to substantially enhance our liquidity and leverage. Over the past 90 days, we have made significant progress on these fronts.

On the liquidity front, as a precaution, we amended our credit agreements to increase our leverage covenant from 4.5 times EBITDA to 5.5 times EBITDA to ensure that we would continue to have access to our $1.875 billion revolver, which provides us more than ample liquidity. However, it has always been our intent to use the revolver as primarily a standby facility. As such, we have raised $1 billion in cash from multiple sources since we last talked to you. This cash has been used to pay off our 2009 maturing bank term loan and all but $100 million of our 2010 maturity. We are very well positioned from a liquidity standpoint with ’09 and ’10 maturities largely dealt with and we can now focus on maturities in 2011 and ’12.

A quick summary of initiatives completed to date. On May 7th, we completed a $500 million offering of 2014 notes with a yield to maturity of 8.75%. On June 5th, we sold $181 million of vacation ownership receivables, realizing cash proceeds of $125 million with an implied interest rate of 8% at very close to book value. In early July, we extended our very successful co-brand partnership with American Express. As part of the broad-based agreement, we received $250 million in cash from AmEx. And on July 22nd, we announced the sale of the W San Francisco for $90 million, but closing next week.

We are not done with our initiatives to both increase liquidity and reduce leverage. We continue to expect a tax refund of over $200 million. Given the internal processes of the IRS, we now expect that this refund will come in later in the year and it is possible it could flip into the early part of the first quarter of 2010. We are also in discussions on a few additional asset sales, which will be executed if we’re satisfied for the terms achievable. Also we will look at another securitization of receivables in the fourth quarter or early next year depending on market conditions.

On the leverage front, we finished the quarter with gross debt of around $3.75 billion and net debt of around $3.6 billion. Our leverage ratio from a covenant standpoint was around four times. Since the quarter closed, our debt has dropped further to $3.5 billion. By the end of the year, after we receive the tax refund and the W San Francisco cash, we project total debt will be below $3.2 billion and net debt around $3 billion. If we complete additional asset sales or another securitization, debt will of course be lower.

For 2009, based on baseline EBITDA of $750 million and total debt of around -- of under $3.2 billion, our leverage ratio will be below 4.3 times. As such, we remain very comfortable that we will stay in compliance with our covenants even if 2010 proves to be another year of declining EBITDA, giving us the ample access to liquidity should we need it.

As you know, we sold the W San Francisco for $90 million in the difficult market. While we think this is not an ideal time to sell a key asset like the W San Francisco, the transaction met the criteria we have set out for asset sales. The multiple was almost 15 times 2009 EBITDA, a sub 5% cap rate, well in excess of our current enterprise multiple, which is around ten times, making the sale accretive.

The sale provided $90 million in additional liquidity and over $60 million contribution to deleverage. There were would also tax attributes associated with the sale that reduced our cash taxes in 2009. The buyer is someone we know well and has been a great owner of several of our hotels in Asia. The contract was long-term at attractive terms, an upside from incentive fees as EBITDA recovers from depressed levels.

As we indicated earlier this year, we will sell a select few assets if terms are acceptable. We have some non-core assets we are in discussions on. These include hotels we do not plan to retain our flag on, non-hotel businesses and land. Our preference would be to sell non-core assets at this point if we can realize good values.

In summary, we feel very good about our access to liquidity and our declining leverage. As we’ve demonstrated in the last 90 days, we have access to multiple sources of liquidity and debt reduction. Bond markets are open. Securitization markets are improving. Asset sales can be executed. We have already completed many of our initiatives ensuring that we no longer have to worry about impending maturities, and our leverage is headed in the right direction. We will announce additional actions when they are completed.

Moving on to a review of business conditions and our outlook. As Frits indicated, we were able to exceed our Q2 guidance despite some significant headwinds. RevPAR was 200 to 300 basis points less than we expected. H1N1 impacted EBITDA by around $10 million worldwide, but more than half of this impact in Mexico. H1N1 impact was felt as far away as Asia, as memories of SARS caused governments to react aggressively in Japan and China. This also affected some key US markets like Hawaii and major gateway cities. SVO was hurt in Mexico and for a few weeks in Orlando.

Once again, tight control of costs, both at the hotel and above the hotel, allowed us to offset these headwinds. Our lean hotel operations project continued to enhance hotel level productivity metrics and flow-through. And as a result of our overhead reduction program, SG&A was down 30%. As expected, occupancy stabilized in Q2 in North America and Europe. And the second derivative of occupancy has continued to improve. But the rate continued to deteriorate.

In the first quarter, rate accounted for 50% of the RevPAR decline, rising to 65% in Q2. Our RevPAR outlook for the balance of the year in North America and Europe is therefore very dependent on the outlook for rate. The fact that rate fails occupancy is fairly typical for happens at this stage in the cycle. What is hard to pin down is the pace at which rates will stabilize. History would suggest it will be one or two quarters after occupancy does.

In North America, mix is skewing towards more price sensitive leisure business. Weakened demand, which is also more price-driven, is stronger than weekday, especially Monday through Wednesday demand. Corporate room nights are down, leisure room nights are up, but there are early indications that corporate business is slowly coming back. Cancellations have moderated. Group production in June was the best so far this year, and there are more leads coming in than we had earlier in the year. But so far, this feels like a slow recovery than a sharp pickup from pent-up demand.

RevPAR declines will be low than Q2, but the absolute level of decline at over 20% is still deep by any historical measure. As such, we remain very focused on cost control. Our guidance implies that the rate of decline moderates even more in Q4, as we left the 15% decline last year. The situation is very similar in Europe with one major difference. Through the first three quarters, we face significant foreign exchange headwinds.

In Q2, local currency RevPAR from company-operated hotels in Europe was down 20% versus down 33% as reported in dollars, a 1,300 basis point translation impact. When we get to Q4, if exchange rates hold at current levels, this Forex impact becomes a tailwind, helping RevPAR as reported in dollars by 300 basis points, a 16 percentage point swing.

In Latin America, the overwhelming factor is swine flu. As you know, we have a large presence in Mexico. In Q2, our Latin American team did an extraordinary job managing to the crisis to minimize our financial impact despite RevPAR dropping almost 60% in Mexico. We will continue to be impacted by swine flu in Q3, reducing profits from prior expectations by $4 million to $5 million. Much like SARS, business is always slow to return. And as winter starts in the Southern Hemisphere, there are advisories on travel in South America, which are already resulting in cancellations to Argentina and Chile. Things will return to normal in Q4 if the virus does not flare up again.

Our Asian business is also dealing with a variety of challenges. Demand is still catching up with supply in major Chinese metros, especially Beijing. It saw a lot of new construction leading up to the Olympics. In India, a general pullback in business travel post to Mumbai attacks has continued. Political instability in Thailand and Fiji, where we own two hotels, has hurt travel.

Japan reacted aggressively to swine flu, also restricting travel. And now we have the bombings in Indonesia. As a result, Asia’s RevPAR decline did not moderate in Q2. Earlier this year, we had expected the Asian business along with Africa and the Middle East to recover fastest. Asia is not recovering yet, and second half expectations for Asia have been lowered. Africa and the Middle East outside Dubai is performing relatively better, with mid-teens RevPAR declines in Q2, a further improvement anticipated.

In our vacation ownership business, close rates have stabilized though at a low level in some markets. Tour flows remained weak especially from owner arrivals. And price realization is under pressure as consumers gravitate towards low price point offerings. In addition, we are closely monitoring our loan portfolio default rates and setting aside deserves as appropriate. Vacation ownership profit for the balance of the year have been lowered to lower interest income as a result of the securitization, which has a $10 million reduction in the second half as well as potentially higher reserve levels for loan losses.

On the SG&A front, we continue to hold down costs. We now project SG&A will be $10 million lower than we had previously forecast, primarily due to lower set-asides for incentive compensation. For the first half, we have been about 30% below last year. As we now left the second half of 2008, when we started making our cuts, the year-over-year reductions we report will be smaller. We remain focused on finding more ways to further fine tune our cost structure, both at the hotel level and above the hotel level.

In summary, stabilization trends have continued across the business, but it appears to be a slow recovery so far. While the RevPAR decline is moderating in relative terms, it is still deep decline in absolute terms. The pace of improvement at this point is dependent on rate, and we are very focused on managing rate realization. We continue our tight focus on costs.

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 you might have as time permits. Tamara, we’re ready for the first question.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll take our first question from Joe Greff with J.P. Morgan.

Joe Greff – J.P. Morgan

Good morning, everyone. On the asset sale front, Vasant, how many core assets are being marketed? And then maybe you can help us quantify the non-core stuff. How many non-core hotel assets are for sale? And then I think a follow-up on a pipeline-related question. Of the pipeline, how much of those are international? How much of those in general are conversion, and percentage of that either being built or fully financed right now? Thank you.

Vasant Prabhu

Asset sales, Joe -- you know, our general preference just given how we like to do these things and just in terms of making sure that we maintain maximum flexibility is never to be too specific about what is on the market. I think we’d rather just stick to what we said in the comments. We have some non-core assets that are in discussion -- that we are in very advanced discussions on. And our preference would be to sell non-core assets. Non-core assets defined as hotels we don’t want to keep our flag on anymore or non-hotel businesses or businesses related to hotels. Our general preference would be core assets like the W San Francisco will only be sold if terms are akin to what you just saw us do on W San Francisco. On pipeline --

Frits van Paasschen

Yes. Joe, this is Frits. On your pipeline question, let me see if I get to all the things you’ve referred to. As we mentioned in the text, about two-thirds of our pipeline today is non-US based. And so that’s been a fairly significant transformation over the last few months. You asked about conversion. It’s a small percentage, significantly less than 10% of the pipeline that’s conversion right now. We expected that number is likely to go up as we look forward. And then in terms of fully financed and under constructions, about half of the reported pipeline is in progress in fully financed from a construction standpoint.

Jason Koval

Next question, please.

Operator

We’ll go next to David Katz, Oppenheimer.

David Katz – Oppenheimer

Hi, good morning. Can we just talk about this AmEx deal and sort of what it means for your leverage paydown? When I look through what your outlook commentary is, it kind of suggests that you kind of have that paydown in the bag. What’s the likelihood that it winds up being -- that that number kind of moves around between now and the end of the quarter? And then the time share stuff, we’ve seen others talk about cutting pricing and it sounds like you are not. Does that -- you know, is there any relationship between what other people are saying and what your strategy might change to? Thanks.

Vasant Prabhu

On the AmEx front, as many of you may know and you may be holders of the AmEx-Starwood co-branded credit card, it’s been a very successful program for us. It’s been in place for several years. Both sides -- both parties have been very happy with the relationship. It’s a very broad-based relationship, includes many facets. Our owners have been big fans of it and it’s been very good for our system. So what we engaged in, it was a mutual desire to extend that arrangement. As a result of that, in exchange for an extension of the agreement and a broad set of -- you know, it’s a broad-based agreement. American Express bought $250 million worth of points that they will be using ratably over the term of the agreement. The cash we’ve already received and use the cash pay down 2010 debt, and it will be a reduction of debt. So there is no real uncertainty about all that. That’s done. In terms of time share, Frits?

Frits van Paasschen

Yes. So your question, David, was with respect to the SVO pricing, and to your point in your question, we have seen some of our competitors taking some aggressive price cuts. We have not, to date. On the other hand, I think the SVO and the vacation ownership business continues to be challenged by the broader economic environment, and we consider -- we continue to consider alternatives. So -- but today, we have not made the choice to reduce price and believe that the strength of our brands is benefiting our sales at the current full price.

Jason Koval

Next question, please.

Operator

We’ll go next to Steven Kent, Goldman Sachs.

Steven Kent – Goldman Sachs

Hi, good morning. Just clarify your earlier comments. I mean, you made almost some fairly draconian views about the broader economic environment and how it’s going to be very, very different this time. And I guess I just wanted to understand that why this hotel’s cycle would be any different from any other hotel cycle and that supply is slowing down, business then will come back with a stronger GDP environment, and it may a little bit longer. But that’s the way this usually goes. So I just wanted to see if there was something different that you were seeing that maybe some of us are not seeing. And then, just separately, maybe Vasant, could you just talk about the multiple you’ve got on the W San Fran was very healthy. Are you seeing that kind of activity when somebody wants a particular property, can you get those kind of multiples?

Frits van Paasschen

Yes. So, Steve, let me respond to the first part of your question in terms of our look at the broader economic environment. And to your point, we don’t see a change in the relationship between GDP and our business. We maintain that that would be a relationship that would be similar to how it’s been before, with the associated lags between rate in occupancy and the pickup in transient before group. I think on the statement we made earlier and then the text that I shared with you all just now, what we are trying to express is that we do feel like from a broader macroeconomic perspective, the recovery from this downturn won’t be as sharp and quick as it’s been in the past. And the fundamental reason for that is, this would be the first recession in a very long time where that growth will have to come at the same time the deleveraging continues.

And therefore, what we are planning internally is for a range of scenarios that say, let’s say that this recovery takes a while to build up steam and doesn’t have the same kind of trajectory it’s had in the past. If we are wrong and if the recovery is more robust than that, we’ll be surprised to the upside. But as we’ve referred to in earlier calls, we continue to want to be conservative in our world view and then therefore very careful from a financial cost containment and leverage perspective, and then one day look forward to being pleasantly surprised on the upside. So with that, let me hand over to Vasant on your question about asset sales.

Vasant Prabhu

I think, Steve -- I mean, it’s hard, as you know, to make blanket statements about what prices can be achieved. I think it’s a function of specific assets and specific buyers who want those assets, and -- which is why we’ve always felt that you want to test the market and you want to -- you know, you have to have criteria as we do under circumstances under which you would do a deal. If someone hits that, then you would do the deal. And if they don’t, then you don’t.

Jason Koval

Next question, please.

Operator

We’ll go next to Felicia Hendrix with Barclays Capital.

Felicia Hendrix – Barclays Capital

Hi, good morning, guys. First, did I hear you say that you were looking at selling non-hotel businesses? So clarify that, but my real question is -- so I just wanted to talk for a second, the outcome of the St. Regis Monarch Beach actually seems to have been the best outcome that you could have imagined under that scenario. I just want to pose the same question to you that I asked to Marriott. And that is, if you could discuss with us what percentage of your management franchise hotels are in some state of payment defaults on their debt service and to the extent that you are engaged in more discussions there, and then if you could walk us through the magnitude of those?

Vasant Prabhu

You know, we are closely monitoring these situations and we know sort of which owners have signaled to us, where there are potential issues. You know, it’s a handful of hotels where the situation may be at an acute level. It’s not broad-based at this point, but we expect that this will continue for a while. And there is a lot of complexity around how CMBS gets resolved et cetera. But like the other hotel chains, we are very much engaged on this with our owners and helping them as much as we can. And I think we’ll know more as we go along here.

Frits van Paasschen

Yes, I think, Felicia, just from my own standpoint, the St. Regis Monarch Beach experience is illustrative to the extent that what it tells you is, first of all, we have strong contracts, and second of all, it’s in the economic interest of whomever the owner is to continue a relationship and management under Starwood. So it’s hard, I think, as Vasant pointed out, to quantify exactly how many properties are in distress, but I think you can comfortably conclude that there will be more distress before there is less, even if the economic cycle picks up team, just because of maturities and the level of leverage that so many owners have. I think, Vasant, there was little more question on --

Vasant Prabhu

Yes. Felicia, I wasn’t sure what your question was on non-hotel businesses, but there are, as you all know, I mean, we’ve always had things that were related to hotels and we do have at least some non-hotel activity. So, to the extent that there is good value realizable on some of those assets, we would look to sell those. But again, only we can meet our own criteria for what’s acceptable value.

Jason Koval

Next question, please.

Operator

We’ll go next to David Loeb with Baird.

David Loeb – Baird

Hi. In terms of the owned hotel margins, our calculation suggests that the margin was down about 45%. 15.5% was the operating margin in North America. What are you doing to try to control that? And can you comment on the risk to management contracts, given performance guarantee terms in any of those [ph]? Does that threaten your MBAs? And then just on housekeeping, the accounting for the AmEx transaction, that increases other liabilities?

Vasant Prabhu

Yes, you have several questions there. At least I’ll answer I think the last two and maybe Frits would -- so on the -- yes, the accounting for the AmEx transaction will be in the other liabilities, and you can see what it is when we release our 10-Q in the next couple of weeks. Your second to last question was -- Jay, can you remind me?

Jason Koval

Performance guarantees.

Vasant Prabhu

Well, I just wanted you to know, I mean, all of this is disclosed in our 10-Ks, but we’ve historically really not like performance guarantees. And we really don’t do them, and we’ve had a few that date back a very long time and it’s very limited. So performance guarantees are really not something we worry about too much at this point. In terms of incentive fees, as you know, our incentive fee mix in the US where they are more linked to preferred returns and therefore much more susceptible to the economic cycle are already very small. So our fee business, as you saw, hasn’t dropped as much as you’ve seen others drop, largely because of our reduced dependence or low dependence on US incentive fees.

Frits van Paasschen

Yes, I think, David, the first part of your question related to owned hotel margins. As we’ve outlined on this call and on previous ones, we’ve had a set of stages of contingency plan cost reductions that we have worked through. We’ve also been going through the lean hotel operations effort, which is really this bottom-up look at how we run our hotels and finding ways to permanent changes in the cost structure there. We are in the midst of that process. So while we don’t have another initiative going on past that at this point, we haven’t yet rolled out our lean hotel operations efforts across the entire system. So that should continue to help us work on improving margins. In the end, what will really help margin is when rates come back.

Jason Koval

Next question, please.

Operator

We’ll go next to Janet Brashear with Sanford Bernstein.

Janet Brashear – Sanford Bernstein

Thank you. Vasant, could you just say a little more on the incentive fees? You said that the mix versus the US was already very small. But relative to the international incentive fees, what trends are you seeing and how low do you expect them to go?

Vasant Prabhu

The international incentive fees, as you know, are not based on preferred returns. I mean, almost all of them are based on first dollar incentives. A typical international contract will give us a certain percentage of GOP. And so you almost have to model how those behave much like you would model how a GOP of a hotel behaves and RevPAR drops. So you would expect that if -- simple rule of thumb that people have often used is, if RevPAR drops 10%, then your gross operating profit may drop 20%. So you would expect your international incentive fees maybe to drop at roughly twice the rate of how much international RevPAR is dropping. On the US side, they were negligible to begin with. And because of the preferred returns, they have gone down, but that doesn’t move the needle very much.

Jason Koval

Next question, please.

Operator

We’ll go next to Bill Crow, Raymond James.

Bill Crow – Raymond James

Good morning. Hey, Frits, Marriott has from time to time used its balance sheet to acquire assets on a short-term basis to protect the brand or the management contract given the distress out there, some of which involves your brands. Should we be surprised if Starwood steps up and buys an asset or two for a short-term hold?

Frits van Paasschen

I think under the circumstances today, it’s less likely than it would be under a more normal environment. Obviously, offsetting that is the fact that you may see some distressed prices that are very attractive. Our preferred approach would be, if a transaction like that were available that we would find partners to work with so that we wouldn’t have to bring much of our own balance sheet to bear to make something like that happen.

Jason Koval

Next question, please.

Operator

We’ll go next to Jeff Donnelly with Wells Fargo Securities.

Jeff Donnelly – Wells Fargo Securities

Good morning, guys. Two-part question I guess to build on David Loeb’s earlier one. I guess, why have been somewhat sluggish then to address the owned hotel margins? Because the declines you’ve seen I guess frankly are quite massive and are perhaps two to four times the declines that peers have delivered. And then I guess as a follow-up, more broadly on cost-cutting, it continues to be the question that gets posed to most management teams. Are you able to quantify for us how much more there is to cut or remove from the structure in the near-term the next six to 12 months, either I guess with the company as a whole or more specifically for your owned hotels?

Frits van Paasschen

Yes, Jeff, let me respond to this, sort of how much more there is to cut question. We started early in addressing cost reductions. And by that I mean, in March and April of last year, as we anticipated that RevPAR declines would likely to hit our way, we undertook a fairly extensive and exhaustive process of looking at costs. We’ve been busy doing that ever since. And I suppose the right way to think about that is, most of the things that are most immediate and that are of the largest magnitude, we got at first. But at the same time, even savings that we identified over the course of that process take time to implement.

So we are still focused on implementing some of the reductions that we identified as we began that process. And at the same time, we’ve taken the attitude that there is always more and that we are continuing to find ways to pull costs out of our cost structure, whether it’s at the hotel level, whether it’s at procurement or whether it’s in corporate overhead. And we’re going to continue to do that. And I think we’ll still continue to show some results. As you plan and project that forward, you have to factor in the fact that we do have our Bliss operations as part of SG&A that there are some one-time puts and takes that we did have, as you would expect, a reduction in incentive comp built into the projection for 2009. So from an operating perspective, there is absolutely more. How that plays out quarter-by-quarter on the P&L is something that we haven’t gotten very specific about.

Jason Koval

Next question, please.

Operator

We’ll go next to Ryan Meliker with Morgan Stanley.

Ryan Meliker – Morgan Stanley

Good morning, guys. Just a quick question for you. First, I was wondering if you could give me some color on what group booking pace is looking for the rest of 2009 and then also 2010, both in terms of bookings and in terms of rate. And then the other thing I wanted to know is, you look like -- from the results published this morning, that the other item in the management fee table that includes Bliss spa revenue actually increased 6% versus a decrease of 40% last quarter. I was wondering if you had any insights into what’s going on there. Thanks a lot.

Vasant Prabhu

In terms of group pace, I don’t think anything we have to say would be different than what you’ve heard from others so far. The total amount of production in the month of June, for example, was quite a bit better than it has been so far this year. Leads are improving. Some of the things you heard in our comments. But the group pace is trending pretty much at the same level as what you heard from our competition sort of in that high-teen to 20% range. The second question was the other line item on the management and revenue line. It is Bliss primarily, but there is also a few things that flow through there that could be of a plus or minus about [ph] one-time variety. Some [ph] termination fees flow through there and a couple of other small items. So those could be swinging it. But Bliss, in general, is fairly stable.

Frits van Paasschen

Yes, I think the only thing I’d add to that, Ryan, is on the group side, we are seeing wide fluctuations in cancellation rates. And I think what you saw as we were going into the down cycle is, as the world deteriorated, a lot of businesses went to cutting costs fairly radically. You might recall also the level of paranoia and concern about being caught traveling that was pervasive certainly a few months back. And what we are starting to see is, as bookings now where we think that the cancellations rate looking forward will be substantially less. And anybody booking a meeting today is doing that in full awareness of the state of the world today and looking forward and saying, this is something that we really need to do as a business. So our view is that the cancellation piece of this should abate, and at the same time, that we are starting to see some pickup in activity that will certainly help as you get to the later part of 2010 and beyond.

Jason Koval

Next question, please.

Operator

We’ll go next to Chris Woronka with Deutsche Bank.

Chris Woronka – Deutsche Bank

Hey, good morning, guys. Why don’t you give us a little color on the rate promotion you launched, I believe, last month and kind of what was the driving force behind that, how it’s going relative to your expectations, and if you see any residual impact of that in terms of expectations changing on from corporate buyers or group buyers or anything like that? Thanks.

Frits van Paasschen

Yes. The response to it has been very good. We looked at this as a short-term tactical effort really just to encourage people to get back out and to stimulate some primary demand in interest. And the logic being that with oil prices down and with some increasing sense that the bottom of -- the bottom won’t fall out of the economy that we could get people to feel that it was safe to go out -- back out into the water again. And the point there was to do it tactically and on a short-term basis and not reset overall rate expectations.

Jason Koval

Next question, please.

Operator

We’ll go next to Will Marks, JMP Securities.

Will Marks – JMP Securities

Good morning. Thank you. I want to talk a little bit more about Sheraton, particularly in North America, and I know you’ve highlighted it a little bit. I guess first of all, I know we can do the unit counts and figure out how big you are versus the whole company. But maybe you could help us with North America Sheraton revenue as a percentage of total revenue or EBITDA or anything? And then second is, Sheraton, the RevPAR was down 25.5% I guess during the quarter. I’m wondering how you did in North America versus competition and is that important. Are you -- is the market share today not meaningful compared to where you expect it to be in a year?

Frits van Paasschen

Yes. First of all, we don’t split out our EBITDA contribution by brand or geography. But in rough numbers, out of the 1,000 hotels we have in the system, about half of them -- slightly over half our rooms are Sheraton and roughly half of those are in North America. In terms of the RevPAR decline, there are lot of puts and takes in those numbers, as you look over a short period of time. As I mentioned earlier on this call, we’ve been renovating pretty significantly across the system. And so when you have 70 hotels under renovation, I think it does have an impact on your business. We still have a number of renovations to complete.

And then even though the guest satisfaction and the response has been very positive, I think it’s safe to say that it will take sometime to build loyalty and reestablish those emotional connections. And so you’ll see some lag in the improvement of the overall portfolio of hotels and the increase in loyalty and returning guests over time. But we see ourselves very much as investing in the future. And candidly, what better time to do that than when occupancy and rate are as low as they are. So the opportunity cost to doing this is as low as it’s ever been.

Jason Koval

Next question, please, Tamara.

Operator

(Operator instructions) We’ll go next to Patrick Scholes, FBR Capital Markets.

Patrick Scholes – FBR Capital Markets

Hi, good morning. When I’m taking a look at your full year RevPAR guidance for the company operated down 20% and I look at what you’ve done so far for the year and what your third quarter -- you know, I back into negative 7% for the fourth quarter. And you also had mentioned there may be some positive FX of about 300 basis points. So is it correct to assume that your real implied guidance for the fourth quarter after backing out what you’ve done is about 10% before foreign exchange?

Frits van Paasschen

Without getting into the specific numbers, I think your logic is mostly right. And it really boils down to two things. When you get to the fourth quarter, we anniversary a minus 15% RevPAR number. And so the simple arithmetic of business at its current level in terms of RevPAR comparison year-on-year changes pretty dramatically. And then as you pointed out, the other flipside to this is the change from foreign exchange detriment of 13% or 1,300 basis points, depending on what your exchange rate is in the fourth quarter. But if you continue where things are today, positive 300. So those two things swing the RevPAR comparison for the fourth quarter but don’t reflect the change in our outlook for the state of the business going into Q4.

Vasant Prabhu

Yes. I mean, a couple of other things that we can add to that just more along those lines is if -- the fourth quarter, as we look at it, doesn’t imply a material improvement in the business from where it is today. So we sort of looked at this. We’ve talked about it before on a two-year stack basis. So if you look at it on a two-year basis, our expectations for the fourth quarter are really not that different from roughly where they are today. Clearly, the Forex in dollar reported terms dramatically changes. And in the second quarter, our entire international portfolio had a Forex headwind of around 800 basis points, and that becomes a tailwind of about 100 basis points. And if you say international is roughly half, that’s a 400 basis point benefit right there just from translation.

And the final point there is, a lot depends on rate. It’s -- the first quarter when rates seriously turned negative was the fourth quarter of last year. So for example, in North America, rate dropped 7% for us in the fourth quarter of last year. So we will be lapping our first big rate declines. And so the question is, will rate continue to drop in percentage terms as last year at the same pace as it was in Q2? And we are assuming that when you start lapping those big negatives, there is some moderation in the trend of rate declines. So that’s some of our logic, but it gets us to where you just said -- what you just said, which is close to high-single digit, double-digit decline in Q4.

Jason Koval

Tamara, I think we have time for one more question, please.

Operator

Okay. We’ll take our final question from William Truelove, UBS.

William Truelove – UBS

All right, I’m last. Okay. So in terms of union hotels as a percentage of your owned and leased hotels, can you give us a flavor for that? And how much is left on the union contracts? And also with -- since it’s just one question, I have to add it all together. What kind of contracted wage growth is embedded in those union contracts? Thanks so much.

Vasant Prabhu

The contracted wage growth would probably in the range of 3% to 4%. And I think the first question was -- what was the first question?

Jason Koval

What percentage of our hotels are unionized?

Frits van Paasschen

Well, it’s roughly one-third that are under collective bargaining agreements.

Vasant Prabhu

In the US.

Frits van Paasschen

In the US.

Jason Koval

Okay. Well, that wraps up today’s second quarter call. We appreciate your time and interest in Starwood Hotels & Resorts. Please feel free to contact us to review any of this information or to follow up with any additional questions. Thanks. Good bye.

Operator

Ladies and gentlemen, that does conclude today’s conference. We appreciate your participation.

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Source: Starwood Hotels & Resorts Worldwide, Inc. Q2 2009 Earnings Call Transcript
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