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HOT > SEC Filings for HOT > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for STARWOOD HOTEL & RESORTS WORLDWIDE, INC

Form 10-Q for STARWOOD HOTEL & RESORTS WORLDWIDE, INC


30-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

This report includes "forward-looking" statements, as that term is defined in the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission in its rules, regulations and releases. Forward-looking statements are any statements other than statements of historical fact, including statements regarding our expectations, beliefs, hopes, intentions or strategies regarding the future. In some cases, forward-looking statements can be identified by the use of words such as "may," "will," "expects," "should," "believes," "plans," "anticipates," "estimates," "predicts," "potential," "continue," or other words of similar meaning. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those discussed in, or implied by, the forward-looking statements. Factors that might cause such a difference include, but are not limited to, general economic conditions, our financial and business prospects, our capital requirements, our financing prospects, our relationships with associates and labor unions, and those disclosed as risks in other reports filed by us with the Securities and Exchange Commission, including those described in Part I of our most recently filed Annual Report on Form 10-K. We caution readers that any such statements are based on currently available operational, financial and competitive information, and they should not place undue reliance on these forward-looking statements, which reflect management's opinion only as of the date on which they were made. Except as required by law, we disclaim any obligation to review or update these forward-looking statements to reflect events or circumstances as they occur.

RESULTS OF OPERATIONS

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

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

On July 1, 2012, we completed an internal management reorganization related to our former hotel segment. Whereas our hotel business had previously been included in a single reportable segment, as a result of this reorganization, these results are now segregated into three separate hotel segments: (i) the Americas, (ii) Europe, Africa and the Middle East ("EAME"), and (iii) Asia Pacific. Our vacation ownership and residential business remains a separate segment. Prior period data has been restated to be consistent with the current year presentation.

In addition to revenues recorded within our four segments, we also have other revenues from managed and franchised properties, which represent the reimbursement of costs incurred on behalf of managed property owners. These revenues, together with the corresponding expenses, are not recorded within our segments. Other corporate unallocated revenues and earnings primarily relate to other license fee income and are also reported outside of segment revenues.

This Management's Discussion and Analysis of Financial Condition and Results of Operations includes discussion of our consolidated operating results, which were unaffected by our internal management reorganization, as well as discussion about each of our four segments. Additionally, Note 20 to the consolidated financial statements presents further information about our segments.


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CRITICAL ACCOUNTING POLICIES

We believe the following to be our critical accounting policies:

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

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

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

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

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

Frequent Guest Program. Starwood Preferred Guest ("SPG") is our frequent guest incentive-marketing program. SPG members earn points based on spending at our owned, managed and franchised hotels, as incentives to first-time buyers of VOIs and residences, and through participation in affiliated partners' programs such as co-branded credit cards. Points can be redeemed at substantially all of our owned, managed and franchised hotels as well as through other redemption opportunities with third parties, such as conversion to airline miles.

We charge our owned, managed and franchised hotels the cost of operating the SPG program, including the estimated cost of our future redemption obligation, based on a percentage of our SPG members' qualified expenditures. The Company's management and franchise agreements require that we be reimbursed for the costs of operating the SPG program, including marketing, promotions and communications and performing member services for the SPG members. As points are earned, the Company increases the SPG point liability for the amount of cash it receives from its managed and franchised hotels related to the future redemption obligation. For our owned hotels, we record an expense for the amount of our future redemption obligation with the offset to the SPG point liability. When points are redeemed by the SPG members, the hotels recognize revenue and the SPG point liability is reduced.


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We, through the services of third-party actuarial analysts, determine the value of the future redemption obligation based on statistical formulas which project the timing of future point redemptions based on historical experience, including an estimate of the "breakage" for points that will never be redeemed, and an estimate of the points that will eventually be redeemed as well as the cost of reimbursing hotels and other third parties in respect of other redemption opportunities for point redemptions.

We consolidate the assets and liabilities of the SPG program including the liability associated with the future redemption obligation which is included in other long-term liabilities and accrued expenses in the accompanying consolidated balance sheets. The total actuarially determined liability as of September 30, 2012 and December 31, 2011 was $872 million and $844 million, respectively, of which $260 million and $251 million, respectively, was included in accrued expenses.

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

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

Loan Loss Reserves. For the vacation ownership and residential segment, we record an estimate of expected uncollectibility on our VOI notes receivable as a reduction of revenue at the time we recognize a timeshare sale. We hold large amounts of homogeneous VOI notes receivable and therefore assess uncollectibility based on pools of receivables. In estimating loan loss reserves, we use a technique referred to as static pool analysis, which tracks defaults for each year's mortgage originations over the life of the respective notes and projects an estimated default rate. As of September 30, 2012, the average estimated default rate for our pools of receivables was approximately 9.8%.

The primary credit quality indicator used by us to calculate the loan loss reserve for the vacation ownership notes is the origination of the notes by brand (Sheraton, Westin, and Other) as we believe there is a relationship between the default behavior of borrowers and the brand associated with the vacation ownership property they have acquired. In addition to quantitatively calculating the loan loss reserve based on our static pool analysis, we supplement the process by evaluating certain qualitative data, including the aging of the respective receivables, current default trends by brand and origination year, and the FICO scores of the buyers.

Given the significance of our respective pools of VOI notes receivable, a change in the projected default rate can have a significant impact to its loan loss reserve requirements, with a 0.1% change estimated to have an impact of approximately $4 million.

We consider a VOI note receivable delinquent when it is more than 30 days outstanding. All delinquent loans are placed on nonaccrual status and we do not resume interest accrual until payment is made. Upon reaching 120 days outstanding, the loan is considered to be in default and we commence the repossession process. Uncollectible VOI notes receivable are charged off when title to the unit is returned to us. We generally do not modify vacation ownership notes that become delinquent or upon default.

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

Legal Contingencies. We are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. An estimated loss from a loss contingency should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or our results of operations.


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Income Taxes. We provide for income taxes in accordance with principles contained in FASB ASC 740, Income Taxes. Under these principles, we recognize the amount of income tax payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns.

Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the new rate is enacted. Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future available taxable income by taxing jurisdiction, the carry-back and carry-forward periods available to us for tax reporting purposes and tax attributes.

We also measure and recognize the amount of tax benefit that should be recorded for financial statement purposes for uncertain tax positions taken or expected to be taken in a tax return. With respect to uncertain tax positions, we evaluate the recognized tax benefits for derecognition, classification, interest and penalties, interim period accounting and disclosure requirements. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns.


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RESULTS OF OPERATIONS

The following discussion presents an analysis of results of our operations for the three and nine months ended September 30, 2012 and 2011.

Despite slowing growth in the global economy, we continued to drive increases in both room rates and occupancy in gateway cities around the world. As we move forward, we believe we are uniquely positioned due to the strength of our brands, our high-end focus, and our geographic diversification. We remain committed to investing in our core operations while also expanding our presence in emerging markets, especially in Asia and Latin America. Starwood is particularly well positioned to take advantage of global growth through our operating teams that have worked in the emerging markets for decades. We also expect to grow in the developed world as new hotel supply remains well below historic rates of growth and we look to build out our underpenetrated brands in these markets. Although we acknowledge that known and unknown challenges could slow or derail the lodging economy, and that uncertainty exists in the United States as well as internationally, we remain optimistic that the strength of our brands will continue to drive strong operating results. We believe that we have the highest quality pipeline in the industry, as measured by percentage growth potential as well as our focus on valuable management contracts in the upper upscale and luxury segments.

At September 30, 2012, we had approximately 370 hotels in the active pipeline representing approximately 95,000 rooms, driven by strong interest in all Starwood brands. Of these rooms, 69% are in the upper upscale and luxury segments and 86% are outside of North America. During the third quarter of 2012, we signed 25 hotel management and franchise contracts representing approximately 4,800 rooms of which 18 are new builds and seven are conversions from another brand. We also opened 20 new hotels and resorts representing approximately 6,500 rooms. During the third quarter of 2012, four hotels left the system, representing approximately 800 rooms.

An indicator of the performance of our owned, leased and consolidated joint venture hotels, as well as our managed and franchised hotels, is REVPAR, as it measures the period-over-period change in rooms' revenue for comparable properties. Along with REVPAR, we also evaluate our hotels by measuring the change in Average Daily Rate ("ADR") and occupancy. This is particularly the case in the United States, where there is no impact on this measure from foreign currency exchange rates.

We continually update and renovate our owned, leased and consolidated joint venture hotels and include these hotels in our Same-Store Owned Hotel results. We also undertake major repositionings of hotels. While undergoing major repositionings, hotels are generally not operating at full capacity and, as such, these repositionings can negatively impact our hotel revenues and are not included in Same-Store Owned Hotel results. We may continue to reposition our owned, leased and consolidated joint venture hotels as we pursue our brand and quality strategies. In addition, several owned hotels are located in regions which are seasonal and, therefore, these hotels do not operate at full capacity throughout the year.


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The following represents our top five markets in the United States by metropolitan area as a percentage of our total owned, leased and consolidated joint venture revenues for the three and nine months ended September 30, 2012 (with comparable data for 2011):

Top Five Metropolitan Areas in the United States as a % of Total Owned Revenues for the Three Months Ended September 30, 2012 with Comparable Data for the Same Period in 2011 (1)

                                          2012            2011
                   Metropolitan Area    Revenues        Revenues
                   New York, NY              11.9 %          12.4 %
                   Hawaii                     7.6 %           6.5 %
                   San Francisco, CA          4.7 %           4.2 %
                   Atlanta, GA                2.6 %           3.4 %
                   Phoenix, AZ                2.6 %           2.6 %

Top Five Metropolitan Areas in the United States as a % of Total Owned Revenues for the Nine Months Ended September 30, 2012 with Comparable Data for the Same Period in 2011 (1)

                                          2012            2011
                   Metropolitan Area    Revenues        Revenues
                   New York, NY              11.7 %          11.5 %
                   Hawaii                     7.0 %           6.0 %
                   Phoenix, AZ                5.6 %           5.1 %
                   San Francisco, CA          4.5 %           4.1 %
                   Atlanta, GA                3.0 %           3.8 %

(1) Includes the revenues of hotels sold for the period prior to their sale.


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The following represents our top five international markets as a percentage of our total owned, leased and consolidated joint venture revenues for the three and nine months ended September 30, 2012 (with comparable data for 2011):

Top Five International Markets as a % of Total Owned Revenues for the Three Months Ended September 30, 2012 with Comparable Data for the Same Period in 2011 (1)

                                            2012            2011
                  International Market    Revenues        Revenues
                  Canada                       11.1 %          11.0 %
                  Spain                         8.2 %           7.4 %
                  Italy                         7.4 %           8.7 %
                  Australia                     4.8 %           4.9 %
                  United Kingdom                4.6 %           4.3 %

Top Five International Markets as a % of Total Owned Revenues for the Nine Months Ended September 30, 2012 with Comparable Data for the Same Period in 2011 (1)

                                            2012            2011
                  International Market    Revenues        Revenues
                  Canada                       10.9 %          11.0 %
                  Italy                         6.8 %           7.7 %
                  Spain                         6.2 %           6.5 %
                  Australia                     4.8 %           4.7 %
                  Mexico                        4.5 %           4.0 %

(1) Includes the revenues of hotels sold for the period prior to their sale.


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Three Months Ended September 30, 2012 Compared with Three Months Ended
September 30, 2011

Consolidated Results



                                                                                                 Increase /
                                                         Three Months        Three Months        (decrease)        Percentage
                                                             Ended               Ended              from             change
                                                         September 30,       September 30,         prior           from  prior
                                                             2012                2011               year              year
                                                                                     (in millions)
Owned, Leased and Consolidated Joint Venture Hotels     $           425     $           441     $        (16 )             (3.6 )%
Management Fees, Franchise Fees and Other Income                    219                 202               17                8.4 %
. . .
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