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20 RESTRUCTURING COSTS AND OTHER CHARGES
During the latter part of 2008, we experienced a significant decline in demand for hotel rooms both domestically and internationally as a result, in part, of the recent failures and near failures of a number of large financial service companies in the fourth quarter of 2008 and the dramatic downturn in the economy. Our capital intensive Timeshare business was also hurt both domestically and internationally by the downturn in market conditions and particularly the significant deterioration in the credit markets, which resulted in our decision not to complete a note sale in the fourth quarter of 2008. These declines resulted in reduced management and franchise fees, cancellation of development projects, reduced timeshare contract sales, and anticipated losses under guarantees and loans. We responded by implementing certain company-wide cost saving measures with individual company segments and corporate departments implementing further cost saving measures. Upper-level management responsible for the Timeshare segment, hotel operations, development, and above-property level management of the various corporate departments and brand teams individually led these decentralized management initiatives. The various initiatives resulted in aggregate restructuring costs of $55 million that we recorded in the fourth quarter of 2008. We also incurred other charges, including charges for guarantees and reserves for loan losses, and inventory write-downs on Timeshare inventory, reserves on accounts receivable, contract cancellation allowances, a charge related to the valuation of Timeshare residual interests, a charge associated with hedge ineffectiveness related to Timeshare note sale hedges, and asset impairments and other charges, detailed further in "Other Charges."
As part of the restructuring efforts in our Timeshare segment, we reduced and consolidated sales channels in the United States and closed down certain operations in Europe. We recorded Timeshare restructuring costs of $28 million in the 2008 fourth quarter, including: (1) $14 million in severance costs; (2) $5 million in facilities exit costs, primarily associated with noncancelable lease costs in excess of estimated sublease income arising from the reduction in personnel; and (3) $9 million related to the write-off of capitalized costs relating to development projects no longer deemed viable. We expect to complete this restructuring by year-end 2009.
As part of the hotel development restructuring efforts across several of our Lodging segments, we discontinued certain development projects that required our investment. We recorded restruc turing costs in the 2008 fourth quarter of $24 million, including: (1) $2 million in severance costs; and (2) $22 million related to the write-off of capitalized costs relating to development projects that we discontinued, including capitalized costs related to owned development of Renaissance ClubSport. We expect to complete this restructuring by year-end 2009.
We also implemented restructuring initiatives by reducing above-property level lodging management personnel and corporate overhead. We incurred 2008 fourth quarter restructuring costs of $3 million primarily reflecting severance costs. We expect to complete this restructuring by year-end 2009.
We have provided detailed information related to these restructuring costs and other charges below.
Restructuring Costs
Severance
These various restructuring initiatives resulted in an overall reduction of 1,021 employees (the majority of whom were terminated by January 2, 2009) across the Company. We recorded a total workforce reduction charge of $19 million related primarily to severance and fringe benefits, which consisted of $14 million for the Timeshare segment, $2 million related to hotel development, and $3 million related to above-property level lodging management and corporate overhead. The charge does not reflect amounts billed out separately to owners for property level severance costs. We also delayed filling vacant positions and reduced staff hours. In connection with these initiatives, we expect to incur an additional $3 million to $4 million related to severance and fringe benefits in 2009 for the Timeshare segment.
Facilities Exit Costs
As a result of workforce reductions and delays in filling vacant positions that were part of the Timeshare segment restructuring, we ceased using certain leased facilities. We recorded a restructuring charge of approximately $5 million associated with these facilities, primarily related to noncancelable lease costs in excess of estimated sublease income. In connection with these initiatives, in 2009, we expect to incur an additional $2 million to $3 million related to ceasing use of additional noncancelable leases.
Development Cancellations
We sometimes incur certain costs associated with the development of hotel and timeshare properties, including legal costs, the cost of land, and planning and design costs. We capitalize these costs as incurred and they become part of the cost basis of the property once it is developed. As a result of the sharp downturn in the economy, we decided to discontinue certain development projects that required our investment, including our Renaissance ClubSport real estate development activities. These cancellations do not impact the two Renaissance ClubSport properties that are currently open. As a result of these development cancellations, we expensed $31 million of previously capitalized costs, which consisted of $9 million of costs for the Timeshare segment and $22 million of costs related to hotel development. We do not currently expect to expense any additional capitalized costs in 2009 in connection with these restructuring initiatives.
Other Charges
Charges for Guarantees and Reserves for Loan Losses
We sometimes issue guarantees to lenders and other third parties in connection with some financing transactions and other obligations. We also advance loans to some owners of properties that we manage. As a result of the downturn in the economy, certain hotels have experienced significant declines in profitability and the owners may not be able to meet debt service obligations to us, or in some cases, to third-party lending institutions. In addition, we expect profit levels at a few hotels to drop below guaranteed levels. As a result, based on cash flow projections, we expect to fund under some of our guarantees, which we do not deem recoverable, and we expect that one of the loans made by us will not be repaid according to its original terms. Due to the expected fundings under guarantees that we deemed nonrecoverable, we recorded charges of $16 million in the fourth quarter of 2008 in the "General, administrative, and other" expenses caption in our Consolidated Statements of Income. Due to the expected loan loss, we recorded a charge of $22 million in the fourth quarter of 2008 in the "Provision for loan losses" caption in our Consolidated Statements of Income.
Timeshare Inventory Write-downs
As a result of terminating certain phases of timeshare development in Europe, we recorded an inventory write-down of $9 million in the fourth quarter of 2008. We recorded this charge in the "Timeshare-direct" caption of our Consolidated Statements of Income.
Accounts Receivable-Bad Debts
In the fourth quarter of 2008, we reserved $4 million of accounts receivable, which we deemed uncollectible, generally as a result of the unfavorable hotel operating environment, following an analysis of those accounts. We recorded this charge in the "General, administrative, and other" expenses caption in our Consolidated Statements of Income.
Timeshare Contract Cancellation Allowances
Our financial statements reflect net contract cancellation allowances totaling $12 million recorded in the 2008 fourth quarter in anticipation that a portion of contract revenue and cost previously recorded for certain projects under the percentage-of-completion method will not be realized due to contract cancellations prior to closing. We have an equity method investment in one of these projects, and reflected $7 million of the $12 million in the "Equity in earnings" caption in our Consolidated Statements of Income. The remaining net $5 million of contract cancellation allowances consisted of a reduction in revenue, net of adjustments to product costs and other direct costs, and was recorded in Timeshare sales and services revenue, net of direct costs.
Timeshare Residual Interests Valuation
The fair market value of our residual interest in timeshare notes sold declined in the fourth quarter of 2008 primarily due to an increase in the market rate of interest at which we discount future cash flows to estimate the fair market value of the retained interests. The increase in the market rate of interest reflects deteriorating economic conditions and disruption in the credit markets, which significantly increased the borrowing costs to issuers. As a result of this change, we recorded a $32 million charge in "Timeshare sales and services" caption in our Consolidated Statements of Income to reflect the decrease in the fair value of these residual interests.
Timeshare Hedge Ineffectiveness
Given the significant deterioration in the credit markets, we expect that any potential note sale transactions pursued by the Company in the near term will be materially different from arrangements originally contemplated, and accordingly, the sensitivity of a hedge the Company previously entered into to manage interest rate risk associated with forecasted note sales no longer significantly corresponds to the sensitivity in expected note sale proceeds. Differences include expected legal structures, modifications to priority of cash flow, and higher costs. The change in terms (inputs) used to determine hedge effectiveness for Timeshare's note sale hedges resulted in the recognition of $12 million in hedge ineffectiveness. We recorded this hedge ineffectiveness as a reduction in note sale gains in the "Timeshare sales and services" caption in our Consolidated Statements of Income.
Asset Impairments and Other Charges
One project that is in development and in which the Company has a joint venture investment was unable to draw on existing financing commitments as a result of the recent turmoil in the capital markets and the bankruptcy of the project's major lender. As a result, based on our analysis of expected future cash flows, we determined that our investment in that joint venture was fully impaired, and we recorded an impairment charge of $9 million in the "Equity in earnings" caption in our Consolidated Statements of Income.
In addition, as a result of the economic downturn and the inability of certain developers to obtain financing, we also recorded write-offs of other assets ($12 million) related to development costs associated with projects we no longer deem probable in the "General, administrative, and other" expenses caption of our Consolidated Statements of Income.
We also deemed certain cost method tax investments to be other-than-temporarily impaired because we do not expect to receive any future economic benefit from these investments. Accordingly, we recorded an impairment charge of $9 million for those investments in the "Gains and other income" caption of our Consolidated Statements of Income.
Summary of Restructuring Costs and Other Charges
The following table is a summary of the restructuring costs and other charges we recorded in the fourth quarter of 2008, as well as our remaining liability at the end of the fourth quarter of 2008 and remaining restructuring costs expected to be incurred in 2009 as part of these restructuring initiatives: |
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