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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 23, 2012
For the transition period from to
Commission File No. 1-13881
MARRIOTT INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 331,005,686 shares of Class A Common Stock, par value $0.01 per share, outstanding at April 6, 2012.
MARRIOTT INTERNATIONAL, INC.
FORM 10-Q TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
($ in millions, except per share amounts)
See Notes to Condensed Consolidated Financial Statements
MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($ in millions)
See Notes to Condensed Consolidated Financial Statements
MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in millions)
See Notes to Condensed Consolidated Financial Statements
MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions)
See Notes to Condensed Consolidated Financial Statements
MARRIOTT INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The condensed consolidated financial statements present the results of operations, financial position, and cash flows of Marriott International, Inc. (“Marriott,” and together with its subsidiaries “we,” “us,” or the “Company”). In order to make this report easier to read, we refer throughout to (i) our Condensed Consolidated Financial Statements as our “Financial Statements,” (ii) our Condensed Consolidated Statements of Income as our “Income Statements,” (iii) our Condensed Consolidated Balance Sheets as our “Balance Sheets,” (iv) our properties, brands, or markets in the United States and Canada as “North America” or “North American,” and (v) our properties, brands, or markets outside of the United States and Canada as “international.”
On November 21, 2011 ("the spin-off date"), we completed a spin-off of our timeshare operations and timeshare development business through a special tax-free dividend to our shareholders of all of the issued and outstanding common stock (the "spin-off") of our wholly owned subsidiary Marriott Vacations Worldwide Corporation ("MVW"). Because of our significant continuing involvement in MVW operations (by virtue of license and other agreements between us and MVW), our former Timeshare segment's historical financial results prior to the spin-off date continue to be included in our historical financial results as a component of continuing operations. See Footnote No. 16, "Spin-off" of the Notes to our Financial Statements in this Form 10-Q for more information on the spin-off.
These condensed consolidated financial statements have not been audited. We have condensed or omitted certain information and footnote disclosures normally included in financial statements presented in accordance with U.S. generally accepted accounting principles (“GAAP”). Although we believe our disclosures are adequate to make the information presented not misleading, you should read the financial statements in this report in conjunction with the consolidated financial statements and notes to those financial statements in our Annual Report on Form 10-K for the fiscal year ended December 30, 2011, (“2011 Form 10-K”). Certain terms not otherwise defined in this Form 10-Q have the meanings specified in our 2011 Form 10-K.
Preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, the reported amounts of revenues and expenses during the reporting periods, and the disclosures of contingent liabilities. Accordingly, ultimate results could differ from those estimates.
Our 2012 first quarter ended on March 23, 2012; our 2011 fourth quarter ended on December 30, 2011; and our 2011 first quarter ended on March 25, 2011. In our opinion, our financial statements reflect all normal and recurring adjustments necessary to present fairly our financial position as of March 23, 2012, and December 30, 2011, the results of our operations for the twelve weeks ended March 23, 2012, and March 25, 2011, and cash flows for the twelve weeks ended March 23, 2012, and March 25, 2011. Interim results may not be indicative of fiscal year performance because of seasonal and short-term variations. We have eliminated all material intercompany transactions and balances between entities consolidated in these financial statements.
Restricted cash in our Balance Sheets at the end of the 2012 first quarter and year-end 2011 is recorded as $7 million and zero, respectively, in the “Other current assets” line and $19 million and $16 million, respectively, in the “Other long-term assets” line. Restricted cash primarily consists of cash held internationally that we have not repatriated due to statutory, tax and currency risks.
Accounting Standards Update No. 2011-04 – “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU No. 2011-04”)
We adopted ASU No. 2011-04 which generally provides a uniform framework for fair value measurements and related disclosures between GAAP and International Financial Reporting Standards (“IFRS”). Additional
disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. The adoption of this update did not have a material impact on our financial statements.
See the “Fair Value Measurements” caption of Footnote No. 1, “Summary of Significant Accounting Policies” of our 2011 Form 10-K for more information on the three levels of fair value measurements.
Accounting Standards Update No. 2011-05 – “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (“ASU No. 2011-05”) and Accounting Standards Update No. 2011-12 - "Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-05" ("ASU No. 2011-12")
We adopted ASU No. 2011-05 in the 2012 first quarter which amends existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous financial statement, a statement of comprehensive income or (2) in two separate but consecutive financial statements, an income statement followed by a separate statement of other comprehensive income. We also adopted ASU No. 2011-12 which defers until further notice ASU No. 2011-05's requirement that items that are reclassified from other comprehensive income to net income be presented on the face of the financial statements. ASU No. 2011-05 required retrospective application. The adoption of these updates changed the order in which we presented certain financial statements, but did not have any other impact on our financial statements.
We file income tax returns, including returns for our subsidiaries, in various jurisdictions around the world. The Internal Revenue Service ("IRS") has examined our federal income tax returns, and we have settled all issues for tax years through 2009. We participated in the IRS Compliance Assurance Program ("CAP") for the 2010 tax year and all but one issue, which we anticipate appealing, are resolved. We participated in CAP for the 2011 tax year, and are participating in CAP for 2012. This program accelerates the examination of key transactions with the goal of resolving any issues before the tax return is filed. Various income tax returns are also under examination by foreign, state and local taxing authorities.
For the first quarter of 2012, we increased unrecognized tax benefits by $1 million from $39 million at year-end 2011 primarily due to new information related to federal and state tax issues. The unrecognized tax benefits balance of $40 million at the end of the 2012 first quarter included $24 million of tax positions that, if recognized, would impact our effective tax rate.
Our shareholders' equity decreased by $17 million as a result of additional MVW spin-off adjustments reducing tax benefits to be recognized on the disposition of the timeshare business.
As a large taxpayer, the IRS and other taxing authorities continually audit us. Although we do not anticipate that a significant impact to our unrecognized tax benefit balance will occur during the next 52 weeks as a result of these audits, it remains possible that the amount of our liability for unrecognized tax benefits could change over that time period.
Under our 2002 Comprehensive Stock and Cash Incentive Plan (the “Comprehensive Plan”), we award: (1) stock options to purchase our Class A Common Stock (“Stock Option Program”); (2) stock appreciation rights (“SARs”) for our Class A Common Stock (“SAR Program”); (3) restricted stock units (“RSUs”) of our Class A Common Stock; and (4) deferred stock units. We grant awards at exercise prices or strike prices equal to the market price of our Class A Common Stock on the date of grant.
We recorded share-based compensation expense related to award grants of $19 million and $21 million for the twelve weeks ended March 23, 2012 and March 25, 2011, respectively. Deferred compensation costs related to unvested awards totaled $185 million and $101 million at March 23, 2012 and December 30, 2011, respectively.
We granted 2.8 million RSUs during the first quarter of 2012 to certain officers and key employees, and those units vest generally over four years in equal annual installments commencing one year after the date of grant. RSUs granted in the first quarter of 2012 had a weighted average grant-date fair value of $35.
SARs and Stock Options
We granted 1.1 million SARs to officers and key employees during the first quarter of 2012. These SARs generally expire ten years after the date of grant and both vest and may be exercised in cumulative installments of one quarter at the end of each of the first four years following the date of grant. The weighted average grant-date fair value of SARs granted in the 2012 first quarter was $12 and the weighted average exercise price was $35.
We granted 0.3 million stock options to officers and key employees during the first quarter of 2012. These stock options expire ten years after the date of grant and generally vest and may be exercised in cumulative installments of one quarter at the end of each of the first four years following the date of grant. The weighted average grant-date fair value of stock options granted in the 2012 first quarter was $12 and the weighted average exercise price was $35.
We used the following assumptions to determine the fair value of the Employee SARs and stock options granted during the first quarter of 2012.
We use a binomial method to estimate the fair value of each SAR granted, under which we calculate the weighted average expected SARs terms as the product of a lattice-based binomial valuation model that uses suboptimal exercise factors. We use historical data to estimate exercise behaviors and terms to retirement for separate groups of retirement eligible and non-retirement eligible employees.
In making these assumptions, we based risk-free rates on the corresponding U.S. Treasury spot rates for the expected duration at the date of grant, which we converted to a continuously compounded rate. We based expected volatility on the weighted-average historical volatility, with periods with atypical stock movement given a lower weight to reflect stabilized long-term mean volatility.
At the end of the 2012 first quarter, we reserved 45 million shares under the Comprehensive Plan, including 21 million shares under the Stock Option Program and the SAR Program.
We believe that the fair values of our current assets and current liabilities approximate their reported carrying amounts. We show the carrying values and the fair values of non-current financial assets and liabilities that qualify as financial instruments, determined in accordance with current guidance for disclosures on the fair value of financial instruments, in the following table.
We estimate the fair value of our senior, mezzanine, and other loans by discounting cash flows using risk-adjusted rates, both of which are Level 3 inputs. We estimate the fair value of our cost method investments by applying a cap rate to stabilized earnings (a market approach using Level 2 inputs). The carrying value of our restricted cash approximates its fair value.
We are required to carry our marketable securities at fair value. We value these securities using directly observable Level 1 inputs. The carrying value of our marketable securities at the end of our 2012 first quarter was $53 million, which included debt securities of the U.S. Government, its sponsored agencies and other U.S. corporations invested for our self-insurance programs as well as shares of a publicly traded company.
We estimate the fair value of our other long-term debt, excluding leases, using expected future payments discounted at risk-adjusted rates, both of which are Level 3 inputs. We determine the fair value of our senior notes using quoted market prices, which are directly observable Level 1 inputs. At year-end 2011 and the end of the 2012 first quarter, the carrying value of our commercial paper approximated its fair value due to the short maturity. Other long-term liabilities primarily consist of guarantee costs, reserves and deposit liabilities. The carrying values of our guarantee costs, reserves and deposit liabilities approximate their fair values.
See the “Fair Value Measurements” caption of Footnote No. 1, “Summary of Significant Accounting Policies” of our 2011 Form 10-K for more information.
The table below illustrates the reconciliation of the earnings and number of shares used in our calculations of basic and diluted earnings per share.
We compute the effect of dilutive securities using the treasury stock method and average market prices during the period. We determine dilution based on earnings.
In accordance with the applicable accounting guidance for calculating earnings per share, we have not included the following stock options and SARs in our calculation of diluted earnings per share because the exercise prices were greater than the average market prices for the applicable periods:
Inventory, totaling $12 million as of March 23, 2012 and $11 million as of December 30, 2011, primarily consists of hotel operating supplies for the limited number of properties we own or lease.
We show the composition of our property and equipment balances in the following table:
In the following table, we show the composition of our assets recorded under capital leases, which we have included in our property and equipment total balances in the preceding table:
We show the composition of our notes receivable balances (net of reserves and unamortized discounts) in the following table:
We classify notes receivable due within one year as current assets in the caption “Accounts and notes receivable” in our Balance Sheets. We show the composition of our long-term notes receivable balances (net of reserves and unamortized discounts) in the following table:
The following tables show future principal payments (net of reserves and unamortized discounts) as well as interest rates, and unamortized discounts for our notes receivable.
Notes Receivable Principal Payments (net of reserves and unamortized discounts) and Interest Rates
Notes Receivable Unamortized Discounts
At the end of the 2012 first quarter, our recorded investment in impaired “Senior, mezzanine, and other loans” was $92 million. We had a $76 million notes receivable reserve representing an allowance for credit losses, leaving $16 million of our investment in impaired loans, for which we had no related allowance for credit losses. At year-end 2011, our recorded investment in impaired “Senior, mezzanine, and other loans” was $96 million, and we had a $78 million notes receivable reserve representing an allowance for credit losses, leaving $18 million of our investment in impaired loans, for which we had no related allowance for credit losses. During the 2012 and 2011 first quarters, our average investment in impaired “Senior, mezzanine, and other loans” totaled $94 million and $86 million, respectively.
The following table summarizes the activity related to our “Senior, mezzanine, and other loans” notes receivable reserve for the first quarter of 2012:
At the end of the 2012 first quarter, past due senior, mezzanine, and other loans totaled $8 million.
We provide detail on our long-term debt balances in the following table:
All of our long-term debt was, and to the extent currently outstanding is, recourse to us but unsecured. Other debt in the preceding table includes capital leases, among other items.
In the first quarter of 2012, we issued $600 million aggregate principal amount of 3.000 percent Series K Notes due 2019 (the "Notes"), completed in two offerings: (1) $400 million aggregate principal amount which closed on February 27, 2012 and (2) $200 million aggregate principal amount which closed on March 14, 2012. We received total net proceeds of approximately $590 million from these offerings, after deducting the underwriting discounts and estimated expenses of these offerings. We expect to use the proceeds for general corporate purposes, which may include working capital, capital expenditures, acquisitions, stock repurchases, or repayment of commercial paper borrowings as they become due.
We will pay interest on the Notes on March 1 and September 1 of each year, commencing on September 1, 2012. The Notes will mature on March 1, 2019, and are redeemable, in whole or in part, at our option, under the terms provided in the form of Note. We issued the Notes under an indenture dated as of November 16, 1998 with The Bank of New York Mellon, as successor to JPMorgan Chase Bank, N.A. (formerly known as The Chase Manhattan Bank), as trustee.
We are party to a multicurrency revolving credit agreement (the “Credit Facility”) that provides for $1.75 billion of aggregate borrowings to support general corporate needs, including working capital, capital expenditures, and letters of credit. The Credit Facility expires on June 23, 2016. The availability of the Credit Facility also supports our commercial paper program. Borrowings under the Credit Facility bear interest at LIBOR (the London Interbank Offered Rate) plus a spread, based on our public debt rating. We also pay quarterly fees on the Credit Facility at a rate also based on our public debt rating. While any outstanding commercial paper borrowings and/or borrowings under our Credit Facility generally have short-term maturities, we classify the outstanding borrowings as long-term based on our ability and intent to refinance the outstanding borrowings on a long-term basis.
We show future principal payments (net of unamortized discounts) and unamortized discounts for our debt in the following tables:
Debt Principal Payments (net of unamortized discounts)
Unamortized Debt Discounts
We paid cash for interest, net of amounts capitalized, of $10 million in the first quarter of 2012 and $24 million in the first quarter of 2011.
The following table details changes in shareholders’ equity.
We issue guarantees to certain lenders and hotel owners, primarily to obtain long-term management contracts. The guarantees generally have a stated maximum amount of funding and a term of four to ten years. The terms of guarantees to lenders generally require us to fund if cash flows from hotel operations are inadequate to cover annual debt service or to repay the loan at the end of the term. The terms of the guarantees to hotel owners generally require us to fund if the hotels do not attain specified levels of operating profit. Guarantee fundings to lenders and hotel owners are generally recoverable as loans repayable to us out of future hotel cash flows and/or proceeds from the sale of hotels. We also enter into project completion guarantees with certain lenders in conjunction with hotels that we or our joint venture partners are building.
We show the maximum potential amount of future fundings for guarantees where we are the primary obligor and the carrying amount of the liability for expected future fundings at March 23, 2012 in the following table.
We included our liability for expected future fundings at March 23, 2012, in our Balance Sheet as follows: $8 million in the “Other current liabilities” and $41 million in the “Other long-term liabilities.”
Our guarantees listed in the preceding table include $4 million of operating profit guarantees and $23 million of debt service guarantees, all of which will not be in effect until the underlying properties open and we begin to operate the properties or certain other events occur.
The guarantees in the preceding table do not include the following:
for 2012 and 2013. In conjunction with our consent of the extension in 2011 of certain lease obligations for an additional five-year term until 2018, Sunrise provided us an additional $1 million cash collateral and an $85 million letter of credit issued by Key Bank to secure our exposure under the lease guarantees for the continuing leases during the extension term and certain other obligations of Sunrise. During the extension term, Sunrise agreed to make an annual payment to us with respect to the cash flow of the continuing lease facilities, subject to a $1 million annual minimum.
In addition to the guarantees described in the preceding paragraphs, in conjunction with financing obtained for specific projects or properties owned by joint ventures in which we are a party, we may provide industry standard indemnifications to the lender for loss, liability, or damage occurring as a result of the actions of the other joint venture owner or our own actions.
Commitments and Letters of Credit
In addition to the guarantees noted in the preceding paragraphs, as of March 23, 2012, we had the following commitments outstanding:
At March 23, 2012, we had $65 million of letters of credit outstanding ($64 million outside the Credit Facility and $1 million under our Credit Facility), the majority of which related to our self-insurance programs. Surety bonds issued as of March 23, 2012, totaled $108 million, the majority of which federal, state and local governments requested in connection with our lodging operations and self-insurance programs.
We are a diversified hospitality company with operations in four business segments:
In addition, prior to the spin-off, our former Timeshare segment consisted of the timeshare operations and timeshare development business that we transferred to MVW in conjunction with the spin-off. Our former Timeshare segment's historical financial results for periods prior to the spin-off date continue to be included in our historical financial results as a component of continuing operations as reflected in the tables that follow. See Footnote No. 16, "Spin-off" for more information on the spin-off.
We evaluate the performance of our segments based primarily on the results of the segment without allocating corporate expenses, income taxes, or indirect general, administrative, and other expenses. We allocate gains and losses, equity in earnings or losses from our joint ventures, divisional general, administrative, and other expenses, and income or losses attributable to noncontrolling interests to each of our segments. “Other unallocated corporate” represents that portion of our revenues, general, administrative, and other expenses, equity in earnings or losses, and other gains or losses that we do not allocate to our segments. "Other unallocated corporate" includes license fees we receive from our credit cards and, following the spin-off, also includes license fees from MVW.
We aggregate the brands presented within our segments considering their similar economic characteristics, types of customers, distribution channels, the regulatory business environments and operations within each segment and our organizational and management reporting structure.
Net Income (Loss)
Equity in Losses of Equity Method Investees
In the first quarter of 2012, we acquired land and a building we plan to develop into a hotel for $160 million in cash. In conjunction with this acquisition, we had also made a cash deposit of $6 million late in 2011.
In accordance with the applicable accounting guidance for the consolidation of variable interest entities, we analyze our variable interests, including loans, guarantees, and equity investments, to determine if an entity in which we have a variable interest is a variable interest entity. Our analysis includes both quantitative and qualitative reviews. We base our quantitative analysis on the forecasted cash flows of the entity, and our qualitative analysis on our review of the design of the entity, its organizational structure including decision-making ability, and relevant financial agreements. We also use our qualitative analyses to determine if we must consolidate a variable interest entity as its primary beneficiary.
In conjunction with the transaction with CTF described more fully in Footnote No. 8, “Acquisitions and Dispositions,” of our Annual Report on Form 10-K for 2007, under the caption “2005 Acquisitions,” we manage hotels on behalf of tenant entities 100 percent owned by CTF, which lease the hotels from third-party owners. Due to certain provisions in the management agreements, we account for these contracts as operating leases. At March 23, 2012, we managed eight hotels on behalf of three tenant entities. The entities have minimal equity and minimal assets comprised of hotel working capital and furniture, fixtures, and equipment. In conjunction with the 2005 transaction, CTF had placed money in a trust account to cover cash flow shortfalls and to meet rent payments. In turn, we released CTF from its guarantees fully in connection with five of these properties and partially in connection with the other three properties. As of year-end 2011, the trust account had been fully depleted. The tenant entities are variable interest entities because the holder of the equity investment at risk, CTF, lacks the ability through voting rights to make key decisions about the entities’ activities that have a significant effect on the success of the entities. We do not consolidate the entities because we do not have: (1) the power to direct the activities that most significantly impact the entities' economic performance or (2) the obligation to absorb losses of the entities or
the right to receive benefits from the entities that could potentially be significant. We are liable for rent payments for five of the eight hotels if there are cash flow shortfalls. Future minimum lease payments through the end of the lease term for these hotels totaled approximately $19 million at the end of the 2012 first quarter. In addition, as of the end of the 2012 first quarter we are liable for rent payments of up to an aggregate cap of $12 million for the three other hotels if there are cash flow shortfalls. Our maximum exposure to loss is limited to the rent payments and certain other tenant obligations under the lease, for which we are secondarily liable.
On November 21, 2011, we completed a spin-off of our timeshare operations and timeshare development business through a special tax-free dividend to our shareholders of all of the issued and outstanding common stock of our wholly owned subsidiary MVW.
As a result of the spin-off, MVW is an independent company whose common shares are listed on the New York Stock Exchange under the symbol "VAC." We do not beneficially own any shares of MVW common stock and do not consolidate MVW's financial results for periods after the spin-off date as part of our financial reporting. However, because of our significant continuing involvement in MVW operations (by virtue of the license and other agreements between us and MVW), our former Timeshare segment's historical financial results for periods prior to the spin-off date continue to be included in Marriott's historical financial results as a component of continuing operations.
Under license agreements entered into effective as of the spin-off date, we receive license fees consisting of a fixed annual fee of $50 million plus two percent of the gross sales price paid to MVW for initial developer sales of interests in vacation ownership units and residential real estate units and one percent of the gross sales price paid to MVW for resales of interests in vacation ownership units and residential real estate units, in each case that are identified with or use the Marriott or Ritz-Carlton marks. The license fee also includes a periodic inflation adjustment. We record these license fees as franchise fee revenues and do not allocate them to any of our segments, but instead include them in "other unallocated corporate."
For more information on the spin-off, see Footnote No. 17, "Spin-Off," of the Notes to our Financial Statements in our 2011 Form 10-K.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We make forward-looking statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report based on the beliefs and assumptions of our management and on information currently available to us. Forward-looking statements include information about our possible or assumed future results of operations, which follow under the headings “Business and Overview,” “Liquidity and Capital Resources,” and other statements throughout this report preceded by, followed by or that include the words “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates” or similar expressions.
Forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those we express in these forward-looking statements, including the risks and uncertainties described below and other factors we describe from time to time in our periodic filings with the U.S. Securities and Exchange Commission (the “SEC”). We therefore caution you not to rely unduly on any forward-looking statements. The forward-looking statements in this report speak only as of the date of this report, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
In addition, see the “Item 1A. Risk Factors” caption in the “Part II-OTHER INFORMATION” section of this report.
BUSINESS AND OVERVIEW
On November 21, 2011 ("the spin-off date"), we completed a spin-off of our timeshare operations and timeshare development business through a special tax-free dividend to our shareholders of all of the issued and outstanding common stock of our wholly owned subsidiary Marriott Vacations Worldwide Corporation ("MVW"). In connection with the spin-off, we entered into several agreements with MVW, and, in some cases, certain of its subsidiaries, that govern our post-spin-off relationship with MVW, including a Separation and Distribution Agreement and two License Agreements for the use of Marriott and Ritz-Carlton marks and intellectual property. Under license agreements with us, MVW is both the exclusive developer and operator of timeshare, fractional, and related products under the Marriott brand and the exclusive developer of fractional and related products under The Ritz-Carlton brand. We now receive license fees from MVW under these license agreements that we include in franchise fees. We do not allocate MVW license fees to any of our segments and instead include them in "other unallocated corporate."
Because of our significant continuing involvement in MVW future operations (by virtue of the license and other agreements between us and MVW), our former Timeshare segment's historical financial results prior to the spin-off date continue to be included in our historical financial results as a component of continuing operations. Please see Footnote No. 16, “Spin-off,” and “Part II, Item 1A – Risk Factors; Other Risks” for more information.
Conditions for our lodging business continued to improve in the first quarter of 2012 reflecting generally low supply growth, a favorable economic climate in many markets around the world, the impact of operating efficiencies across our company, and a year-over-year increase in the number of hotels. The U.S. economy continues to improve broadly; however, there are still some markets, particularly the greater Washington D.C. market, that continue to have weak demand. Economic growth in Europe was moderate during the 2012 first quarter, and demand in the Middle East continued to be weak.
We remain focused on doing the things that we do well; that is, selling rooms, taking care of our guests, and making sure we control our costs. Our brands remain strong as a result of skilled management teams, dedicated associates, superior customer service with an emphasis on guest and associate satisfaction, significant distribution,
our Marriott Rewards and The Ritz-Carlton Rewards loyalty programs, a multichannel reservations system, and desirable property amenities. We, along with owners and franchisees, continue to invest in our brands by means of new, refreshed, and reinvented properties, new room and public space designs, and enhanced amenities and technology offerings. We also remove hotels from our system that no longer meet our standards. We continue to enhance the appeal of our proprietary, information-rich, and easy-to-use website, Marriott.com, through functionality and service improvements, and we expect to continue capturing an increasing proportion of property-level reservations via this cost-efficient channel.
In the first quarter of 2012 as compared to the year ago quarter, worldwide average daily rates increased 3.5 percent on a constant dollar basis to $133.78 for comparable systemwide properties, with Revenue per Available Room ("RevPAR") increasing 6.8 percent to $88.49 and occupancy increasing 2.0 percentage points to 66.1 percent.
For properties in North America in the first quarter of 2012, most markets experienced strong demand. In the greater Washington, D.C. market, government spending restrictions and a short congressional calendar continued to reduce lodging demand, especially impacting the surrounding suburban markets. For properties in China, Thailand, Japan, Brazil, and Mexico, demand was particularly strong during the first quarter of 2012. In Europe, demand was strong in international gateway cities but weaker in markets dependent on more regional demand. Occupancy rates at properties in the Middle East largely remained weak reflecting continued unrest in that region, although demand was strong in the United Arab Emirates in the first quarter.
We monitor market conditions continuously and carefully price our rooms daily to meet individual hotel demand levels. We modify the mix of our business to increase revenue as demand changes. Demand for higher rated rooms continued to improve in the first quarter of 2012, which allowed us to reduce discounting and special offers for transient business. This mix improvement benefited average daily rates.
The hotels in our system serve both transient and group customers. Overall, business transient and leisure transient demand was strong in the first quarter of 2012, while group demand continued to strengthen. The group revenue booking pace for comparable North American Marriott Hotels & Resorts properties for the remainder of 2012 is up over 11 percent compared to only 2 percent a year ago and 9 percent last quarter. Group customers typically book rooms and meeting space with significant lead times, sometimes several years in advance of guest arrival. Typically, two-thirds of group business is booked prior to the year of arrival and one-third is booked in the year of arrival. During an economic recovery, group pricing tends to lag transient pricing due to the significant lead times for group bookings. Group business booked in earlier periods at lower rates continues to roll off, and with improving group demand, is being replaced with bookings reflecting generally higher rates. In the 2012 first quarter, group customers spent more on their meetings and property-level food and beverage volumes improved. Additionally, we saw an increase in short term bookings for both large and small groups during the 2012 first quarter, and attendance at meetings frequently exceeded initial projections.
Our approach to property-level and above-property productivity has benefited our profitability, as well as that of owners and franchisees. Properties in our system continue to maintain very tight cost controls. We also control above-property costs, some of which we allocate to hotels, by remaining focused on systems, processing, and support areas.
Our lodging business model involves managing and franchising hotels, rather than owning them. At March 23, 2012, we operated 44 percent of the hotel rooms in our worldwide system under management agreements, our franchisees operated 53 percent under franchise agreements, we owned or leased 2 percent, and 1 percent were operated or franchised through unconsolidated joint ventures. Our emphasis on long-term management contracts and franchising tends to provide more stable earnings in periods of economic softness, while the addition of new hotels to our system generates growth, typically with little or no investment by the company. This strategy has allowed substantial growth while reducing financial leverage and risk in a cyclical industry. In addition, we believe we increase our financial flexibility by reducing our capital investments and adopting a strategy of recycling the investments that we make.
During the first quarter of 2012, we added 3,234 rooms (gross) to our system. Approximately 36 percent of new rooms were located outside the United States and 29 percent of the room additions were conversions from competitor brands. We currently have nearly 115,000 rooms in our lodging development pipeline. For the full 2012 fiscal year, we expect to add 25,000 to 30,000 rooms (gross) to our system with approximately half of the expected room openings located outside the United States. We expect 7,000 to 8,000 rooms to exit the system, largely due to quality issues. The figures in this paragraph do not include residential, timeshare, or ExecuStay units.
We consider RevPAR, which we calculate by dividing room sales for comparable properties by room nights available to guests for the period, to be a meaningful indicator of our performance because it measures the period-over-period change in room revenues for comparable properties. RevPAR may not be comparable to similarly titled measures, such as revenues. References to RevPAR throughout this report are in constant dollars, unless otherwise noted. Constant dollar statistics are calculated by applying exchange rates for the current period to the prior comparable period.
Company-operated house profit margin is the ratio of property-level gross operating profit (also known as house profit) to total property-level revenue. We consider house profit margin to be a meaningful indicator of our performance because this ratio measures our overall ability as the operator to produce property-level profits by generating sales and controlling the operating expenses over which we have the most direct control. House profit includes room, food and beverage, and other revenue and the related expenses including payroll and benefits expenses, as well as repairs and maintenance, utility, general and administrative, and sales and marketing expenses. House profit does not include the impact of management fees, furniture, fixtures and equipment replacement reserves, insurance, taxes, or other fixed expenses.
We earn base management fees and incentive management fees on the hotels that we manage, and we earn franchise fees on the hotels operated by others under franchise agreements with us. Base fees are typically a percentage of property-level revenue while incentive fees are typically a percentage of net house profit adjusted for a specified owner return. Net house profit is calculated as gross operating profit (house profit) less non-controllable expenses such as insurance, real estate taxes, capital spending reserves, and the like.
As noted in the preceding "Business and Overview" section, we completed the spin-off of our timeshare operations and timeshare development business in late 2011. Accordingly, we no longer have a Timeshare segment and instead now earn license fees that we do not allocate to any of our segments and instead include in "other unallocated corporate." The following table details the components of our former Timeshare segment revenues and results for the 2011 first quarter and also shows the components of revenues we received from MVW for the 2012 first quarter.
1 Segment results for our former Timeshare segment for the twelve weeks ended March 25, 2011 of $35 million include interest expense allocated to our former Timeshare segment of $12 million.
The following discussion presents an analysis of results of our operations for the twelve weeks ended March 23, 2012, compared to the twelve weeks ended March 25, 2011. The results for the 2011 first quarter include the results of the former Timeshare segment.
Revenues decreased by $226 million (8 percent) to $2,552 million in the first quarter of 2012 from $2,778 million in the first quarter of 2011. As detailed in the preceding table, the spin-off contributed to a net $326 million decrease in revenues that was partially offset by a $100 million increase in revenues in our lodging business.
The $100 million increase in revenues for our lodging business was a result of: higher cost reimbursements revenue ($86 million), higher franchise fees ($10 million), higher incentive management fees ($8 million (comprised of a $3 million increase for North America and a $5 million increase outside of North America)), and higher base management fees ($3 million), partially offset by lower owned, leased, corporate housing, and other revenue ($7 million).
Cost reimbursements revenue represents reimbursements of costs incurred on behalf of managed and franchised properties and relates, predominantly, to payroll costs at managed properties where we are the employer,
but also includes reimbursements for other costs, such as those associated with our Marriott Rewards and Ritz-Carlton Rewards programs. As we record cost reimbursements based upon costs incurred with no added markup, this revenue and related expense has no impact on either our operating income or net income. We also receive cost reimbursements revenue from MVW for reimbursement of certain costs incurred in conjunction with transition services agreements and participation in our rewards program. The $36 million increase in total cost reimbursements revenue, to $2,035 million in the 2012 first quarter from $1,999 million in the 2011 first quarter, reflected an $86 million increase (allocated across our lodging business) as result of the impact of higher property-level demand and growth across the system, partially offset by a net $50 million decline in timeshare-related cost reimbursements due to the spin-off. Net of hotels exiting the system, we added 887 managed rooms and 11,719 franchised rooms to our system since the end of the 2011 first quarter.
The decrease in total base management fees, to $124 million in the 2012 first quarter from $134 million in the 2011 first quarter, primarily reflected a decline of $13 million in former Timeshare segment base management fees due to the spin-off, partially offset by a net increase of $3 million across our lodging business as a result of stronger RevPAR. The net increase of $3 million included the unfavorable impact of $3 million of fee reversals in the 2012 first quarter for two properties to reflect contract revisions. The increase in total franchise fees, to $126 million in the 2012 first quarter from $103 million in the 2011 first quarter, primarily reflected an increase of $13 million in MVW license fees due to the spin-off and an increase of $10 million across our lodging business as a result of stronger RevPAR and, to a lesser extent, the impact of unit growth across the system. The increase in incentive management fees from $42 million in the first quarter of 2011 to $50 million in the first quarter of 2012 primarily reflected higher net property-level income resulting from higher property-level revenue, particularly for certain properties in: Florida and West Coast resorts in the United States; eastern Europe; Mexico; and China. The increase also reflected continued property-level cost controls and, to a lesser extent, new unit growth in international markets.
The decrease in owned, leased, corporate housing, and other revenue, to $217 million in the 2012 first quarter, from $224 million in the 2011 first quarter, primarily reflected $6 million of lower hotel agreement termination fees and $3 million of lower revenue from owned and leased properties, partially offset by $2 million of higher corporate housing and other revenue. Combined branding fees associated with card endorsements and the sale of branded residential real estate by others totaled $16 million for both the 2012 and 2011 first quarters.
Operating income decreased by $16 million to $175 million in the 2012 first quarter from $191 million in the 2011 first quarter. As detailed in the preceding table, the spin-off contributed to a net $34 million decrease in operating income that was partially offset by an $18 million increase in operating income across our lodging business. This $18 million increase reflected a $10 million increase in franchise fees, an $8 million increase in incentive management fees, a $3 million increase in base management fees, and $2 million of higher owned, leased, corporate housing, and other revenue net of direct expenses, partially offset by a $5 million increase in general, administrative and other expenses. We discuss the reasons for the increases in base management fees, franchise fees, and incentive management fees across our lodging business as compared to the 2011 first quarter in the preceding “Revenues” section.
General, administrative, and other expenses decreased by $12 million (8 percent) to $147 million in the first quarter of 2012 from $159 million in the first quarter of 2011. The decrease reflected a decline of $17 million due to the spin-off, partially offset by an increase of $5 million across our lodging business primarily as a result of $3 million of higher legal expenses and $3 million of increased other expenses primarily associated with higher costs in international markets and initiatives to enhance and grow our brands globally.
The $5 million increase in total general, administrative, and other expenses across our lodging business consisted of a $4 million increase that we did not allocate to any of our segments, a $1 million increase allocated to our North American Full-Service segment, and a $1 million increase allocated to our North American Limited-Service segment, partially offset by a $1 million decrease allocated to our Luxury segment.
The $2 million (10 percent) increase in owned, leased, corporate housing, and other revenue net of direct
expenses was primarily attributable to $6 million of net stronger results at some owned and leased properties due to higher RevPAR and property-level margins and $2 million of higher corporate housing and other revenue net of direct expenses, partially offset by $6 million of lower hotel agreement termination fees.
Gains and Other Income
Gains and other income of $2 million for both the first quarter of 2012 and first quarter of 2011 reflected gains on sales of real estate.
Interest expense decreased by $8 million (20 percent) to $33 million in the first quarter of 2012 compared to $41 million in the first quarter of 2011. This decrease was primarily due to the spin-off as interest expense in the 2011 first quarter that was allocated to the former Timeshare segment totaled $12 million. This decrease was partially offset by a $4 million increase in interest expense for our lodging business primarily related to our Marriott Rewards program ($3 million) as well as increased interest expense associated with the Series K Notes issued in the first quarter of 2012 ($1 million). See the “LIQUIDITY AND CAPITAL RESOURCES” caption later in this report for additional information on the Series K Notes.
Interest Income and Income Tax
Interest income of $4 million in the first quarter of 2012 was unchanged compared to the first quarter of 2011, primarily reflecting a $3 million increase related to two new notes receivable issued in conjunction with the spin-off , offset by a $3 million decrease primarily associated with the repayment of certain loans subsequent to the 2011 first quarter.
Our tax provision decreased by $8 million (16 percent) to a tax provision of $43 million in the first quarter of 2012 from a tax provision of $51 million in the first quarter of 2011. The decrease was primarily due to the resolution of closed tax year items and lower pretax income in 2012, primarily due to the income before taxes impact of the spin-off as noted in the following "Net Income" discussion, partially offset by tax provision to tax return true-ups.
Equity in Losses
Equity in losses of $1 million in the first quarter of 2012 decreased by $3 million from equity in losses of $4 million in the first quarter of 2011 and reflected $3 million of increased earnings primarily for one North American Limited-Service joint venture and one International segment joint venture, due to stronger property-level performance.
Net income increased by $3 million to $104 million in the first quarter of 2012 from $101 million in the first quarter of 2011, and diluted earnings per share increased by $0.04 per share (15 percent) to $0.30 per share from $0.26 per share in the first quarter of 2011. As discussed in more detail in the preceding sections beginning with “Operating Income,” the $3 million increase in net income compared to the year-ago quarter was due to higher franchise fees across our lodging business ($10 million), higher incentive management fees across our lodging business ($8 million), lower income taxes ($8 million), higher base management fees across our lodging business ($3 million), lower equity in losses ($3 million), and higher owned, leased, corporate housing, and other revenue net of direct expenses ($2 million). These increases were partially offset by the income before taxes impact of the spin-off ($22 million), higher general, administrative, and other expenses across our lodging business ($5 million), and higher interest expense across our lodging business ($4 million).
Earnings Before Interest Expense, Taxes, Depreciation and Amortization (“EBITDA”) and Adjusted EBITDA
EBITDA, a financial measure that is not prescribed or authorized by United States generally accepted accounting principles (“GAAP”), reflects earnings excluding the impact of interest expense, provision for income taxes, depreciation and amortization. We consider EBITDA to be an indicator of operating performance because we
use it to measure our ability to service debt, fund capital expenditures, and expand our business. We also use EBITDA, as do analysts, lenders, investors and others, to evaluate companies because it excludes certain items that can vary widely across different industries or among companies within the same industry. For example, interest expense can be dependent on a company’s capital structure, debt levels and credit ratings. Accordingly, the impact of interest expense on earnings can vary significantly among companies. The tax positions of companies can also vary because of their differing abilities to take advantage of tax benefits and because of the tax policies of the jurisdictions in which they operate. As a result, effective tax rates and provision for income taxes can vary considerably among companies. EBITDA also excludes depreciation and amortization because companies utilize productive assets of different ages and use different methods of both acquiring and depreciating productive assets. These differences can result in considerable variability in the relative costs of productive assets and the depreciation and amortization expense among companies.
We also evaluate Adjusted EBITDA, another non-GAAP financial measure, as an indicator of operating performance. Our Adjusted EBITDA reflects Timeshare Spin-off Adjustments for 2011 ("Timeshare Spin-off Adjustments") as if the spin-off occurred on the first day of 2011. The Timeshare Spin-off Adjustments to net income of $13 million for the 2011 first quarter totaled $21 million pre-tax and are primarily comprised of the following pre-tax items: 1) removal of the results of our former Timeshare segment ($35 million); 2) the addition of a payment by MVW to us of estimated license fees ($14 million); 3) the addition of estimated interest income ($3 million); and 4) the addition of estimated interest expense ($3 million).
We evaluate Adjusted EBITDA that excludes these items to make period-over-period comparisons of our ongoing core operations before material charges. EBITDA and Adjusted EBITDA also facilitate our comparison of results from our ongoing operations before material charges with results from other lodging companies.
EBITDA and Adjusted EBITDA have limitations and should not be considered in isolation or as substitutes for performance measures calculated in accordance with GAAP. Both of these non-GAAP measures exclude certain cash expenses that we are obligated to make. In addition, other companies in our industry may calculate EBITDA and Adjusted EBITDA differently than we do or may not calculate them at all, limiting EBITDA's and Adjusted EBITDA's usefulness as comparative measures. We provide Adjusted EBITDA for illustrative and informational purposes only and this measure is not necessarily indicative of and does not purport to represent what our operating results would have been had the spin-off occurred on the first day of 2011. This information also does not reflect certain financial and operating benefits we expect to realize as a result of the spin-off.
We show our first quarter 2012 and 2011 EBITDA and Adjusted EBITDA calculations and reconcile those measures with Net Income in the following tables.
We are a diversified hospitality company with operations in four business segments: North American Full-Service Lodging, North American Limited-Service Lodging, International Lodging, and Luxury Lodging. See Footnote No. 13, “Business Segments,” of the Notes to our Financial Statements for further information on our segments including how we aggregate our individual brands into each segment and other information about each segment, including revenues, net income, equity in earnings (losses) of equity method investees, and assets.
We added 129 properties (20,111 rooms) and 34 properties (6,251 rooms) exited our system since the end of the 2011 first quarter. These figures do not include residential or ExecuStay units. During that time we also added 5 residential properties (529 units) and no residential properties exited the system. These net property additions include 8 hotels (904 rooms) which are operated or franchised as part of our unconsolidated joint venture with AC Hoteles, S.A.
Total segment financial results decreased by $10 million to $229 million in the first quarter of 2012 from $239 million in the first quarter of 2011, and total segment revenues decreased by $259 million to $2,503 million in the first quarter of 2012, a 9 percent decrease from revenues of $2,762 million in the first quarter of 2011. As detailed in the preceding table, the spin-off resulted in a $35 million decrease in segment results, partially offset by a net $25 million increase in segment results across our lodging business. Similarly, the spin-off resulted in a $358 million decrease in segment revenues, that was partially offset by a net $99 million increase in revenues across our lodging business.
The quarter-over-quarter net increase in segment revenues of $99 million across our lodging business was a result of an $86 million increase in cost reimbursements revenue, a $10 million increase in franchise fees, an $8 million increase in incentive management fees, and a $3 million increase in base management fees, partially offset by an $8 million decrease in owned, leased, corporate housing and other revenue. The quarter-over-quarter increase in segment results of $25 million across our lodging business reflected a $10 million increase in franchise fees, an $8 million increase in incentive management fees, $3 million of lower joint venture equity losses, an increase of $3
million in base management fees, and an increase of $2 million in owned, leased, corporate housing, and other revenue net of direct expenses, partially offset by a $1 million increase in general, administrative, and other expenses. For more detailed information on the variances see the preceding sections beginning with “Operating Income.”
In the first quarter of 2012, 29 percent of our managed properties paid incentive management fees to us versus 25 percent in the first quarter of 2011. In addition, in the first quarter of 2012 and the first quarter of 2011, 61 percent of our incentive fees came from properties outside the United States.
See “Statistics” below for detailed information on Systemwide RevPAR and Company-operated RevPAR by segment, region, and brand.
Compared to the first quarter of 2011, worldwide comparable company-operated house profit margins in the first quarter of 2012 increased by 120 basis points and worldwide comparable company-operated house profit per available room (“HP-PAR”) increased by 9.6 percent on a constant U.S. dollar basis, reflecting higher occupancy, rate increases, improved productivity, and favorable benefits costs. These same factors as well as lower energy costs due to a mild winter, contributed to North American company-operated house profit margins increasing by 130 basis points compared to the 2011 first quarter. HP-PAR at those same properties increased by 10.7 percent. International company-operated house profit margins increased by 70 basis points, and HP-PAR at those properties increased by 6.6 percent reflecting increased demand and higher RevPAR in most locations and improved productivity, partially offset by the effects of RevPAR declines in the Middle East.
Summary of Properties by Brand
Including residential properties, we added 24 lodging properties (3,234 rooms) during the first quarter of 2012, while 10 properties (2,487 rooms) exited the system including nearly 700 rooms converting to residential use, increasing our total properties to 3,732 (643,943 rooms). These figures include 34 home and condominium products (3,838 units), for which we manage the related owners’ associations.
Unless otherwise indicated, our references to Marriott Hotels & Resorts throughout this report include JW Marriott and Marriott Conference Centers, references to Renaissance Hotels include Renaissance ClubSport, and references to Fairfield Inn & Suites include Fairfield Inn.
At March 23, 2012, we operated, franchised, or licensed the following properties by brand (excluding 2,095 corporate housing rental units):
Total Lodging and Timeshare Products by Segment
At March 23, 2012, we operated, franchised, and licensed the following properties by segment (excluding 2,095 corporate housing rental units associated with our ExecuStay brand):