XFRA:MAQ Marriott International Inc Class A Quarterly Report 10-Q Filing - 9/7/2012

Effective Date 9/7/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________ 
FORM 10-Q
_______________________________________ 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 7, 2012
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File No. 1-13881
_______________________________________ 
MARRIOTT INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
 _______________________________________
Delaware
 
52-2055918
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
10400 Fernwood Road, Bethesda, Maryland
(Address of principal executive offices)
 
20817
(Zip Code)
(301) 380-3000
(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.
 
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller Reporting Company
 
¨
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: 315,540,075 shares of Class A Common Stock, par value $0.01 per share, outstanding at September 21, 2012.




MARRIOTT INTERNATIONAL, INC.
FORM 10-Q TABLE OF CONTENTS
 
 
 
Page No.
 
 
 
Part I.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 



1


PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
($ in millions, except per share amounts)
(Unaudited)
 
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
 
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
REVENUES
 
 
 
 
 
 
 
Base management fees
$
134

 
$
136

 
$
399

 
$
419

Franchise fees
149

 
124

 
420

 
347

Incentive management fees
36

 
29

 
142

 
121

Owned, leased, corporate housing, and other revenue
200

 
254

 
681

 
727

Timeshare sales and services

 
286

 

 
850

Cost reimbursements
2,210

 
2,045

 
6,415

 
6,160

 
2,729

 
2,874

 
8,057

 
8,624

OPERATING COSTS AND EXPENSES
 
 
 
 
 
 
 
Owned, leased, and corporate housing-direct
174

 
219

 
572

 
643

Timeshare-direct

 
250

 

 
720

Timeshare strategy - impairment charges

 
324

 

 
324

Reimbursed costs
2,210

 
2,045

 
6,415

 
6,160

General, administrative, and other
132

 
180

 
439

 
498

 
2,516

 
3,018

 
7,426

 
8,345

OPERATING INCOME (LOSS)
213

 
(144
)
 
631

 
279

Gains (losses) and other income
36

 
(16
)
 
43

 
(11
)
Interest expense
(29
)
 
(39
)
 
(96
)
 
(117
)
Interest income
3

 
2

 
10

 
9

Equity in losses
(1
)
 
(2
)
 
(10
)
 
(6
)
INCOME (LOSS) BEFORE INCOME TAXES
222

 
(199
)
 
578

 
154

(Provision) benefit for income taxes
(79
)
 
20

 
(188
)
 
(97
)
NET INCOME (LOSS)
$
143

 
$
(179
)
 
$
390

 
$
57

EARNINGS PER SHARE-Basic
 
 
 
 
 
 
 
Earnings (losses) per share
$
0.45

 
$
(0.52
)
 
$
1.19

 
$
0.16

EARNINGS PER SHARE-Diluted
 
 
 
 
 
 
 
Earnings (losses) per share
$
0.44

 
$
(0.52
)
 
$
1.16

 
$
0.15

CASH DIVIDENDS DECLARED PER SHARE
$
0.1300

 
$
0.1000

 
$
0.3600

 
$
0.2875

See Notes to Condensed Consolidated Financial Statements

2


MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($ in millions)
(Unaudited)

 
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
 
 
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
Net income (loss)
 
$
143

 
$
(179
)
 
$
390

 
$
57

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
5

 
(2
)
 
(1
)
 
13

Other derivative instrument adjustments, net of tax
 

 
(11
)
 
1

 
(25
)
Unrealized gain (loss) on available-for-sale securities, net of tax
 

 

 
(1
)
 
(10
)
Reclassification of losses, net of tax
 
(1
)
 
8

 

 
8

Total other comprehensive income (loss), net of tax
 
4

 
(5
)
 
(1
)
 
(14
)
Comprehensive income (loss)
 
$
147

 
$
(184
)
 
$
389

 
$
43


See Notes to Condensed Consolidated Financial Statements


3


MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in millions)
 
 
(Unaudited)
 
 
 
September 7,
2012
 
December 30,
2011
ASSETS
 
 
 
Current assets
 
 
 
Cash and equivalents
$
105

 
$
102

Accounts and notes receivable
841

 
875

Inventory
11

 
11

Current deferred taxes, net
146

 
282

Prepaid expenses
45

 
54

Other
10

 

 
1,158

 
1,324

Property and equipment
1,421

 
1,168

Intangible assets
 
 
 
Goodwill
874

 
875

Contract acquisition costs and other
898

 
846

 
1,772

 
1,721

Equity and cost method investments
217

 
265

Notes receivable
171

 
298

Deferred taxes, net
851

 
873

Other
275

 
261

 
$
5,865

 
$
5,910

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities
 
 
 
Current portion of long-term debt
$
408

 
$
355

Accounts payable
594

 
548

Accrued payroll and benefits
668

 
650

Liability for guest loyalty program
514

 
514

Other
506

 
491

 
2,690

 
2,558

Long-term debt
2,101

 
1,816

Liability for guest loyalty program
1,434

 
1,434

Other long-term liabilities
936

 
883

Shareholders’ equity
 
 
 
Class A Common Stock
5

 
5

Additional paid-in-capital
2,515

 
2,513

Retained earnings
3,434

 
3,212

Treasury stock, at cost
(7,201
)
 
(6,463
)
Accumulated other comprehensive loss
(49
)
 
(48
)
 
(1,296
)
 
(781
)
 
$
5,865

 
$
5,910


See Notes to Condensed Consolidated Financial Statements

4


MARRIOTT INTERNATIONAL, INC. (“MARRIOTT”)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions)
(Unaudited)
 
 
Thirty-Six Weeks Ended
 
September 7,
2012
 
September 9,
2011
OPERATING ACTIVITIES
 
 
 
Net income
$
390

 
$
57

Adjustments to reconcile to cash provided by operating activities:
 
 
 
Depreciation and amortization
100

 
116

Income taxes
154

 
20

Timeshare activity, net

 
158

Timeshare strategy - impairment charges

 
324

Liability for guest loyalty program
(9
)
 
32

Restructuring costs, net

 
(4
)
Asset impairments and write-offs
13

 
32

Working capital changes and other
160

 
150

Net cash provided by operating activities
808

 
885

INVESTING ACTIVITIES
 
 
 
Capital expenditures
(316
)
 
(128
)
Dispositions
65

 
1

Loan advances
(2
)
 
(20
)
Loan collections and sales
126

 
109

Equity and cost method investments
(12
)
 
(71
)
Contract acquisition costs
(52
)
 
(54
)
Other
(22
)
 
18

Net cash used in investing activities
(213
)
 
(145
)
FINANCING ACTIVITIES
 
 
 
Commercial paper/credit facility, net
110

 
397

Issuance of long-term debt
590

 

Repayment of long-term debt
(368
)
 
(196
)
Issuance of Class A Common Stock
81

 
99

Dividends paid
(110
)
 
(100
)
Purchase of treasury stock
(884
)
 
(1,225
)
Other financing activities
(11
)
 

Net cash used in financing activities
(592
)
 
(1,025
)
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
3

 
(285
)
CASH AND EQUIVALENTS, beginning of period
102

 
505

CASH AND EQUIVALENTS, end of period
$
105

 
$
220

See Notes to Condensed Consolidated Financial Statements


5


MARRIOTT INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.
Basis of Presentation
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 after the spin-off (by virtue of license and other agreements between us and MVW), we continue to include the historical financial results before the spin-off date of our former Timeshare segment 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 third quarter ended on September 7, 2012; our 2011 fourth quarter ended on December 30, 2011; and our 2011 third quarter ended on September 9, 2011. In our opinion, our financial statements reflect all normal and recurring adjustments necessary to present fairly our financial position as of September 7, 2012, and December 30, 2011, the results of our operations for the twelve and thirty-six weeks ended September 7, 2012, and September 9, 2011, and cash flows for the thirty-six weeks ended September 7, 2012, and September 9, 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
Restricted cash in our Balance Sheets at the end of the 2012 third quarter and year-end 2011 is recorded as $9 million and zero, respectively, in the “Other current assets” line and $20 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.

2.
New Accounting Standards
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”)

6


We adopted ASU No. 2011-04 in the 2012 first quarter 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.


3.
Income Taxes
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 are 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 third quarter of 2012, we increased our unrecognized tax benefits by $4 million from $40 million at the end of the 2012 second quarter primarily due to a reclassification to deferred tax assets of expenses related to the timeshare spin-off. For the first three quarters of 2012, we increased unrecognized tax benefits by $5 million from $39 million at year-end 2011 primarily due to an increase in our position related to the spin-off of our timeshare operations. The unrecognized tax benefits balance of $44 million at the end of the 2012 third quarter included $28 million of tax positions that, if recognized, would impact our effective tax rate.
We recorded a net $12 million adjustment in the first three quarters of 2012 to reduce shareholders' equity, primarily 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.

7



4.
Share-Based Compensation
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 $22 million for the twelve weeks ended September 7, 2012 and September 9, 2011, respectively, and $57 million and $65 million for the thirty-six weeks ended September 7, 2012 and September 9, 2011, respectively. Deferred compensation costs related to unvested awards totaled $139 million and $101 million at September 7, 2012 and December 30, 2011, respectively.
RSUs
We granted 2.8 million RSUs during the first three quarters 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 three quarters of 2012 had a weighted average grant-date fair value of $35.
SARs and Stock Options
We granted 1.1 million SARs to officers, key employees, and directors during the first three quarters 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 first three quarters of 2012 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 three quarters 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 first three quarters of 2012 was $12 and the weighted average exercise price was $35.

On the grant date, we use a binomial lattice-based valuation model to estimate the fair value of each SAR and option granted. This valuation model uses a range of possible stock price outcomes over the term of the SAR and option, discounted back to a present value using a risk-free rate. Because of the limitations with closed-form valuation models, such as the Black-Scholes model, we have determined that a more flexible binomial model provides a better estimate of the fair value of our options and SARs because it takes into account employee exercise behavior based on changes in the price of our stock and allows for the use of other dynamic assumptions.

We used the following assumptions to determine the fair value of the SARs and stock options granted to employees and directors during the first three quarters of 2012.
 
Expected volatility
31
%
Dividend yield
1.01
%
Risk-free rate
1.7 - 2.0%

Expected term (in years)
8 - 10


In making these assumptions, we base expected volatility on the weighted average historical stock volatility. We base risk-free rates on the corresponding U.S. Treasury spot rates for the expected duration at the date of grant, which we convert to a continuously compounded rate. The dividend yield assumption takes into consideration both historical levels and expectations of future payout. The weighted average expected terms for SARs and options are a

8


n output of our valuation model which utilizes historical data in estimating the period of time that the SARs and options are expected to remain unexercised. We calculate the expected terms for SARs and options for separate groups of retirement eligible and non-retirement eligible employees. Our valuation model also uses historical data to estimate exercise behaviors, which includes determining the likelihood that employees will exercise their SARs and options before expiration at a certain multiple of stock price to exercise price.

Other Information

At the end of the 2012 third quarter, we reserved 43 million shares under the Comprehensive Plan, including 19 million shares under the Stock Option Program and the SAR Program.

5.
Fair Value of Financial Instruments
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.
 
 
At September 7, 2012
 
At Year-End 2011
($ in millions)
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Cost method investments
$
23

 
$
27

 
$
31

 
$
25

Senior, mezzanine, and other loans
171

 
164

 
298

 
252

Restricted cash
20

 
20

 
16

 
16

Marketable securities
51

 
51

 
50

 
50

 
 
 
 
 
 
 
 
Total long-term financial assets
$
265

 
$
262

 
$
395

 
$
343

Senior Notes
$
(1,484
)
 
$
(1,657
)
 
$
(1,286
)
 
$
(1,412
)
Commercial paper
(441
)
 
(441
)
 
(331
)
 
(331
)
Other long-term debt
(132
)
 
(137
)
 
(137
)
 
(137
)
Other long-term liabilities
(98
)
 
(98
)
 
(77
)
 
(77
)
 
 
 
 
 
 
 
 
Total long-term financial liabilities
$
(2,155
)
 
$
(2,333
)
 
$
(1,831
)
 
$
(1,957
)
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. The carrying value of our restricted cash approximates its fair value.
We estimate the fair value of our cost method investments by applying a cap rate to stabilized earnings (a market approach using Level 3 inputs). During the third quarter of 2012, we determined that a cost method investment was other-than-temporarily impaired and accordingly, we recorded the investment at its fair value as of the end of the 2012 third quarter ($12 million) and reflected the $7 million loss in the "(Losses) gains and other income" caption of our Income Statement. We estimated the fair value of the investment using cash flow projections discounted at risk premiums commensurate with market conditions. We used Level 3 inputs for these discounted cash flow analyses and our assumptions included revenue forecasts, cash flow projections, and timing of the sale of each hotel in the underlying investment.
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 third quarter was $51 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. During the third quarter of 2011, we determined that the shares of a publicly traded company that we hold were other-than-temporarily impaired and, accordingly, at the end of the 2011 third quarter we recognized an $18 million loss which we reflected in the "(Losses) gains and other income" caption of our Income Statement. This loss included $10

9


million of losses that had been recorded in other comprehensive income as of the end of the 2011 second quarter, which were also included in the "Reclassification of losses" caption of our Condensed Consolidated Statements of Comprehensive Income for the twelve and thirty-six weeks ended September 9, 2011.
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 third 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.
We estimate that the fair values of the Company's letters of credit and surety bonds are the same as the contract values based on the nature of the fee arrangements with the issuing financial institutions. See Footnote No. 12, "Contingencies" for the related balances.
See the “Fair Value Measurements” caption of Footnote No. 1, “Summary of Significant Accounting Policies” of our 2011 Form 10-K for more information.

6.
Earnings Per Share
The table below illustrates the reconciliation of the earnings and number of shares used in our calculations of basic and diluted earnings per share.
 
 
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
 
 
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
(in millions, except per share amounts)
 
 
 
 
 
 
 
 
Computation of Basic Earnings Per Share
 
 
 
 
 
 
 
 
Net income (loss)
 
$
143

 
$
(179
)
 
$
390

 
$
57

Weighted average shares outstanding
 
319.4

 
345.4

 
327.0

 
356.5

Basic earnings (losses) per share
 
$
0.45

 
$
(0.52
)
 
$
1.19

 
$
0.16

Computation of Diluted Earnings Per Share
 
 
 
 
 
 
 
 
Net income (loss)
 
$
143

 
$
(179
)
 
$
390

 
$
57

Weighted average shares outstanding
 
319.4

 
345.4

 
327.0

 
356.5

Effect of dilutive securities
 
 
 
 
 
 
 
 
Employee stock option and SARs plans
 
6.0

 

 
6.5

 
9.2

Deferred stock incentive plans
 
0.8

 

 
0.9

 
0.9

Restricted stock units
 
3.1

 

 
3.1

 
3.2

Shares for diluted earnings per share
 
329.3

 
345.4

 
337.5

 
369.8

Diluted earnings (losses) per share
 
$
0.44

 
$
(0.52
)
 
$
1.16

 
$
0.15


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. We did not include the following shares in the “Effect of dilutive securities” caption in the preceding table, as it would have been antidilutive to do so because we recorded a loss for the 2011 third quarter: 7.7 million employee stock option and SARs plans shares, 0.9 million deferred stock incentive plans shares, and 2.8 million restricted stock unit shares.

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:
(a)
for the twelve-week period ended September 7, 2012, 1.0 million options and SARs;
(b)
for the twelve-week period ended September 9, 2011, 4.2 million options and SARs;
(c)
for the thirty-six week period ended September 7, 2012, 1.0 million options and SARs; and

10


(d)
for the thirty-six week period ended September 9, 2011, 1.0 million options and SARs.

7.
Inventory
Inventory, totaling $11 million as of both September 7, 2012 and December 30, 2011, primarily consists of hotel operating supplies for the limited number of properties we own or lease.

8.
Property and Equipment
We show the composition of our property and equipment balances in the following table:
 
 
At Period End
($ in millions)
September 7,
2012
 
December 30,
2011
Land
$
553

 
$
454

Buildings and leasehold improvements
682

 
667

Furniture and equipment
842

 
810

Construction in progress
322

 
164

 
2,399

 
2,095

Accumulated depreciation
(978
)
 
(927
)
 
$
1,421

 
$
1,168


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:
 
At Period End
($ in millions)
September 7,
2012
 
December 30,
2011
Land
$
29

 
$
30

Buildings and leasehold improvements
135

 
128

Furniture and equipment
37

 
34

Construction in progress
4

 
3

 
205

 
195

Accumulated depreciation
(80
)
 
(76
)
 
$
125

 
$
119


9.
Notes Receivable
We show the composition of our notes receivable balances (net of reserves and unamortized discounts) in the following table:
 
 
At Period End
($ in millions)
September 7,
2012
 
December 30,
2011
Senior, mezzanine, and other loans
$
256

 
$
382

Less current portion
(85
)
 
(84
)
 
$
171

 
$
298


11


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:
 
 
At Period End
($ in millions)
September 7,
2012
 
December 30,
2011
Loans to equity method investees
$

 
$
2

Other notes receivable
171

 
296

 
$
171

 
$
298


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
 
($ in millions)
 
Amount
2012
 
$
34

2013
 
66

2014
 
44

2015
 
41

2016
 

Thereafter
 
71

Balance at September 7, 2012
 
$
256

Weighted average interest rate at September 7, 2012
 
4.9
%
Range of stated interest rates at September 7, 2012
 
0 to 12.7%



Notes Receivable Unamortized Discounts
 
($ in millions)
 
Total
Balance at year-end 2011
 
$
12

Balance at September 7, 2012
 
$
12


At the end of the 2012 third quarter, our recorded investment in impaired “Senior, mezzanine, and other loans” was $102 million, we had an $88 million notes receivable reserve representing an allowance for credit losses, leaving $14 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 first three quarters of 2012 and full fiscal year 2011, our average investment in impaired “Senior, mezzanine, and other loans” totaled $99 million and $89 million, respectively.

12


The following table summarizes the activity related to our “Senior, mezzanine, and other loans” notes receivable reserve for the first three quarters of 2012:
 
($ in millions)
Notes  Receivable
Reserve
Balance at year-end 2011
$
78

Additions
2

Reversals
(1
)
Write-offs
(1
)
Transfers and other
10

Balance at September 7, 2012
$
88

At the end of the 2012 third quarter, past due senior, mezzanine, and other loans totaled $7 million.

10.
Long-term Debt
We provide detail on our long-term debt balances in the following table:
 
 
At Period End
($ in millions)
September 7,
2012
 
December 30,
2011
Senior Notes:
 
 
 
Series F, matured June 15, 2012
$

 
$
348

Series G, interest rate of 5.810%, face amount of $316, maturing November 10, 2015 (effective interest rate of 6.51%)(1)
308

 
307

Series H, interest rate of 6.200%, face amount of $289, maturing June 15, 2016 (effective interest rate of 6.27%)(1)
289

 
289

Series I, interest rate of 6.375%, face amount of $293, maturing June 15, 2017 (effective interest rate of 6.42%)(1)
292

 
291

Series J, interest rate of 5.625%, face amount of $400, maturing February 15, 2013 (effective interest rate of 5.68%)(1)
400

 
399

Series K, interest rate of 3.000%, face amount of $600, maturing March 1, 2019 (effective interest rate of 4.08%)(1)
594

 

Commercial paper, average interest rate of 0.4158% at September 7, 2012
441

 
331

$1,750 Credit Facility

 

Other
185

 
206

 
2,509

 
2,171

Less current portion
(408
)
 
(355
)
 
$
2,101

 
$
1,816

 
(1) 
Face amount and effective interest rate are as of September 7, 2012.

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.

During our 2012 third quarter, we entered into a terms agreement with J.P. Morgan Securities LLC, Wells Fargo Securities, LLC, and other underwriters to issue $350 million aggregate principal amount of 3.250 percent Series L Notes due 2022 (the "Series L Notes"). The offering of the Notes closed after the end of the 2012 third quarter, on September 10, 2012. We received net proceeds of approximately $346 million from the offering of the Notes, after deducting the underwriting discount and estimated expenses. We will pay interest on the Series L Notes on March 15 and September 15 of each year, commencing on March 15, 2013. The Notes will mature on September 15, 2022, and we may redeem them, in whole or in part, at our option, under the terms provided in the form of Note.
At the end of the second quarter of 2012, we made a $356 million cash payment of principal and interest to retire, at maturity, all of our outstanding Series F Notes.

13


In the first quarter of 2012, we issued $600 million aggregate principal amount of 3.000 percent Series K Notes due 2019 (the "Series K Notes") under the Indenture, 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 underwriting discounts and estimated expenses. We pay interest on the Series K Notes on March 1 and September 1 of each year, which commenced on September 1, 2012. The Notes will mature on March 1, 2019, and we may redeem them, in whole or in part, at our option, under the terms provided in the form of Note.
We issued both the Series K and the Series L 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)
 
($ in millions)
 
Amount
2012
 
$
2

2013
 
408

2014
 
46

2015
 
316

2016
 
738

Thereafter
 
999

Balance at September 7, 2012
 
$
2,509

Unamortized Debt Discounts
 
($ in millions)
 
Amount
Balance at year-end 2011
 
$
12

Balance at September 7, 2012
 
$
16


We paid cash for interest, net of amounts capitalized, of $62 million in the first three quarters of 2012 and $94 million in the first three quarters of 2011.

14



11.
Capital Structure

The following table details changes in shareholders’ equity.
 
(in millions, except per share amounts)
 
 
Common
Shares
Outstanding
 
 
Total
 
Class A
Common
Stock
 
Additional
Paid-in-
Capital
 
Retained
Earnings
 
Treasury Stock,
at Cost
 
Accumulated
Other
Comprehensive
Loss
333.0

 
Balance at year-end 2011
$
(781
)
 
$
5

 
$
2,513

 
$
3,212

 
$
(6,463
)
 
$
(48
)

 
Net income
390

 

 

 
390

 

 


 
Other comprehensive loss
(1
)
 

 

 

 

 
(1
)

 
Cash dividends ($0.3600 per share)
(117
)
 

 

 
(117
)
 

 

5.3

 
Employee stock plan issuance
128

 

 
14

 
(51
)
 
165

 

(24.3
)
 
Purchase of treasury stock
(903
)
 

 

 

 
(903
)
 


 
Spin-off of MVW adjustment
(12
)
 

 
(12
)
 

 

 

314.0

 
Balance at September 7, 2012
$
(1,296
)
 
$
5

 
$
2,515

 
$
3,434

 
$
(7,201
)
 
$
(49
)

12.
Contingencies
Guarantees

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 measure our liability for guarantees at fair value on a non-recurring basis, that is when we issue the guarantee or when an existing guarantee is modified, using Level 3 internally developed inputs. We generally base our calculation of the estimated fair value of a guarantee on the income approach or the market approach, depending on the type of guarantee. For the income approach, we use internally developed discounted cash flow and Monte Carlo simulation models that include, among others, the following assumptions: projections of revenues and expenses and related cash flows based on assumed growth rates and demand trends; historical volatility of projected performance; the guaranteed obligations; and applicable discount rates. We base these assumptions on our historical data and experience, industry projections, micro and macro general economic condition projections, and our expectations. For the market approach, we use internal analyses based primarily on market comparable data and our assumptions about market capitalization rates, credit spreads, growth rates, and inflation.

We show the maximum potential amount of future fundings and the carrying amount of the liability for guarantees at September 7, 2012 for which we are the primary obligor in the following table.
 
($ in millions)
Guarantee Type
Maximum Potential
Amount  of Future Fundings

 
Liability for  Guarantees
Debt service
$
88

 
$
7

Operating profit
144

 
71

Other
13

 
2

Total guarantees where we are the primary obligor
$
245

 
$
80

   
We included our liability for guarantees at September 7, 2012 for which we are the primary obligor in our

15


Balance Sheet as follows: $10 million in the “Other current liabilities” and $70 million in the “Other long-term liabilities.”

Our guarantees listed in the preceding table include $40 million of operating profit guarantees and $34 million of debt service guarantees that 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:
$145 million of guarantees related to Senior Living Services lease obligations of $111 million (expiring in 2018) and lifecare bonds of $34 million (estimated to expire in 2016), for which we are secondarily liable. Sunrise Senior Living, Inc. (“Sunrise”) is the primary obligor on both the leases and $5 million of the lifecare bonds; Health Care Property Investors, Inc., as successor by merger to CNL Retirement Properties, Inc. (“CNL”), is the primary obligor on $28 million of the lifecare bonds, and Five Star Senior Living is the primary obligor on the remaining $1 million of lifecare bonds. Before we sold the Senior Living Services business in 2003, these were our guarantees of obligations of our then consolidated Senior Living Services subsidiaries. Sunrise and CNL have indemnified us for any fundings we may be called upon to make under these guarantees. Our liability associated with these guarantees had a carrying value of $3 million at September 7, 2012. In 2011 Sunrise provided us $3 million cash collateral to cover potential exposure under the existing lease and bond obligations 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.
Lease obligations, for which we became secondarily liable when we acquired the Renaissance Hotel Group N.V. in 1997, consisting of annual rent payments of approximately $6 million and total remaining rent payments through the initial term of approximately $39 million. Most of these obligations expire by the end of 2020. CTF Holdings Ltd. (“CTF”) had originally provided €35 million in cash collateral in the event that we are required to fund under such guarantees, approximately $5 million (€4 million) of which remained at September 7, 2012. Our exposure for the remaining rent payments through the initial term will decline to the extent that CTF obtains releases from the landlords or these hotels exit the system. Since the time we assumed these guarantees, we have not funded any amounts, and we do not expect to fund any amounts under these guarantees in the future.
Certain guarantees and commitments relating to the timeshare business, which were outstanding at the time of the 2011 Timeshare spin-off and for which we became secondarily liable as part of the spin-off. These MVW payment obligations, for which we currently have a total exposure of $32 million, relate to a project completion guarantee, various letters of credit, and several guarantees. MVW has indemnified us for these obligations. Most of the obligations expire in 2012, 2013, and 2014, except for one guarantee in the amount of $20 million (Singapore Dollars 24 million) that expires in 2022. We have not funded any amounts under these obligations, and do not expect to do so in the future. Our liability for these obligations had a carrying value of $2 million at September 7, 2012. 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 of our timeshare operations and timeshare development business.
A recoverable $69 million operating profit guarantee, originally entered into in 2000, for which we became secondarily liable in the 2012 first quarter upon the restructuring of agreements for certain Ritz-Carlton properties. The operating profit guarantee for which we became secondarily liable in the 2012 first quarter obligates us to fund up to $69 million and was, at year-end 2011, a $69 million guarantee obligation for which we were the primary obligor and had fully funded. During the 2012 first quarter, we were repaid for the $69 million note receivable plus interest for the guarantee fundings. In the 2012 first quarter, we entered into an agreement with an entity with a net worth of

16


approximately $1 billion (the "Entity"), whereby the Entity agreed to immediately reimburse us for any fundings under the operating profit guarantee. The Entity is obligated to maintain certain liquidity and net worth covenants in support of this obligation to us. Most of this operating profit guarantee and corresponding Entity guarantee to us will expire in 2014 with a final expiration in 2016.
A project completion guarantee that we provided to a lender for a joint venture project with an estimated aggregate total cost of $515 million (Canadian $511 million). The associated joint venture will satisfy payments for cost overruns for this project through contributions from the partners or from borrowings, and we are liable on a several basis with our partners in an amount equal to our 20 percent pro rata ownership in the joint venture. In 2010, our partners executed documents indemnifying us for any payments that may be required for this guarantee obligation. Our liability associated with this project completion guarantee had a carrying value of $3 million at September 7, 2012. As of the end of the 2012 third quarter, we satisfied our obligations under this guarantee and we expect to be released by the lender in the fourth quarter of 2012.
A guarantee related to a lease, originally entered into in 2000, for which we became secondarily liable in the 2012 second quarter as a result of the sale of the ExecuStay corporate housing business to Oakwood. Oakwood has indemnified us for the obligations under this guarantee. Our total exposure at the end of the 2012 third quarter for this guarantee is $11 million in future rent payments if the lease is terminated through 2013 and will be reduced to $6 million if the lease is terminated from 2014 through the end of the lease in 2019. Our liability associated with this guarantee had a carrying value of $1 million at September 7, 2012.
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 September 7, 2012, we had the following commitments outstanding:
Commitments to invest up to $17 million of equity for noncontrolling interests in partnerships that plan to purchase North American full-service and limited-service properties, or purchase or develop hotel-anchored mixed-use real estate projects. We expect to fund these commitments within three years as follows: $2 million in 2012, $10 million in 2013, and $5 million in 2014.
A commitment to invest up to $24 million of equity for noncontrolling interests in partnerships that plan to develop limited-service properties. We expect to fund $21 million of this commitment within two years as follows: $8 million in 2012 and $13 million in 2013. We do not expect to fund the remaining $3 million of this commitment.
A commitment, with no expiration date, to invest up to $11 million in a joint venture for development of a new property that we expect to fund in 2013.
A commitment to invest $20 million in the renovation of a leased hotel. We expect to fund this commitment by 2015.
We have a right and under certain circumstances an obligation to acquire our joint venture partner’s remaining 50 percent interest in two joint ventures over the next nine years at a price based on the performance of the ventures. We made a $12 million (€9 million) deposit in conjunction with this contingent obligation in 2011, a $4 million (€3 million) deposit in the second quarter of 2012, and the final deposit of $4 million (€3 million) in the third quarter of 2012. The deposits are refundable to the extent we do not acquire our joint venture partner’s remaining interests.
We have a right and under certain circumstances an obligation to acquire the landlord’s interest in the real estate property and attached assets of a hotel that we lease for approximately $41 million (€33

17


million) during the next two years.
Various commitments for the purchase of information technology hardware, software, and maintenance services in the normal course of business totaling $55 million. We expect to fund these commitments within three years as follows: $6 million in 2012, $47 million in 2013, and $2 million in 2014.
Several commitments aggregating $32 million with no expiration date and which we do not expect to fund.
A commitment, expiring in the 2012 fourth quarter, to invest up to $1 million which we do not expect to fund.
$2 million of loan commitments that we have extended to owners of lodging properties. We do not expect to fund these commitments, $1 million of which will expire within three years and $1 million will expire after five years.

At September 7, 2012, we had $64 million of letters of credit outstanding ($63 million outside the Credit Facility and approximately $1 million under our Credit Facility), the majority of which related to our self-insurance programs. Surety bonds issued as of September 7, 2012, totaled $118 million, the majority of which federal, state and local governments requested in connection with our self-insurance programs.
Legal Proceedings
On January 19, 2010, several former Marriott employees (the "plaintiffs") filed a putative class action complaint against us and the Stock Plan (the "defendants"), alleging that certain equity awards of deferred bonus stock granted to the plaintiffs and other current and former employees for fiscal years 1963 through 1989 are subject to vesting requirements under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), that are in certain circumstances more rapid than those set forth in the awards, various other purported ERISA violations, and various breaches of contract in connection with the awards. The plaintiffs seek damages, class attorneys' fees and interest, with no amounts specified. The action is proceeding in the United States District Court for the District of Maryland (Greenbelt Division) and Dennis Walter Bond Sr. and Michael P. Steigman are the current named plaintiffs. The parties currently are engaged in limited discovery concerning the issues of statute of limitations and class certification. We anticipate filing a motion for summary judgment in the fall of 2012. We and the Stock Plan have denied all liability, and while we intend to vigorously defend against the claims being made by the plaintiffs, we can give you no assurance about the outcome of this lawsuit. We currently cannot estimate the range of any possible loss to the Company because an amount of damages is not claimed, there is uncertainty as to whether a class will be certified and if so as to the size of the class, and the possibility of our prevailing on our statute of limitations defense may significantly limit any claims for damages.
In March 2012, the Korea Fair Trade Commission ("KFTC") obtained documents from two of our managed hotels in Seoul, Korea in connection with an investigation which we believe is focused on pricing of hotel services within the Seoul region. We understand that the KFTC also has sought documents from approximately ten other hotels in the Seoul region that we do not operate, own or franchise. We have not yet received a complaint or other legal process. We are cooperating with this investigation.

13.
Business Segments
We are a diversified lodging company with operations in four business segments:
North American Full-Service Lodging, which includes the Marriott Hotels & Resorts, Marriott Conference Centers, JW Marriott, Renaissance Hotels, Renaissance ClubSport, and Autograph Collection properties located in the United States and Canada;
North American Limited-Service Lodging, which includes the Courtyard, Fairfield Inn & Suites, SpringHill Suites, Residence Inn, and TownePlace Suites properties located in the United States and Canada, and, before its sale in the 2012 second quarter, our Marriott ExecuStay corporate housing business;

18


International Lodging, which includes the Marriott Hotels & Resorts, JW Marriott, Renaissance Hotels, Autograph Collection, Courtyard, AC Hotels by Marriott, Fairfield Inn & Suites, Residence Inn, and Marriott Executive Apartments properties located outside the United States and Canada; and
Luxury Lodging, which includes The Ritz-Carlton, Bulgari Hotels & Resorts, and EDITION properties worldwide (together with residential properties associated with some Ritz-Carlton hotels).

In addition, before 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 before 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.
Revenues
 
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
($ in millions)
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
North American Full-Service Segment
$
1,332

 
$
1,232

 
$
4,006

 
$
3,788

North American Limited-Service Segment
612

 
587

 
1,735

 
1,653

International Segment
321

 
293

 
898

 
860

Luxury Segment
394

 
362

 
1,221

 
1,138

Former Timeshare Segment

 
377

 

 
1,125

Total segment revenues
2,659

 
2,851

 
7,860

 
8,564

Other unallocated corporate
70

 
23

 
197

 
60

 
$
2,729

 
$
2,874

 
$
8,057

 
$
8,624


19


Net Income (Loss)
 
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
($ in millions)
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
North American Full-Service Segment
$
76

 
$
71

 
$
275

 
$
238

North American Limited-Service Segment
157

 
97

 
347

 
267

International Segment
36

 
35

 
117

 
116

Luxury Segment
20

 
8

 
66

 
46

Former Timeshare Segment

 
(302
)
 

 
(238
)
Total segment financial results
289

 
(91
)
 
805

 
429

Other unallocated corporate
(41
)
 
(81
)
 
(141
)
 
(201
)
Interest expense and interest income (1)
(26
)
 
(27
)
 
(86
)
 
(74
)
Income taxes
(79
)
 
20

 
(188
)
 
(97
)
 
$
143

 
$
(179
)
 
$
390

 
$
57

 
(1) 
Of the $39 million and $117 million of interest expense shown on the Income Statement for the twelve and thirty-six weeks ended September 9, 2011, respectively, we allocated $10 million and $34 million, respectively, to our former Timeshare Segment.

Equity in Losses of Equity Method Investees
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
($ in millions)
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
North American Full-Service Segment
$

 
$
1

 
$
1

 
$
1

North American Limited-Service Segment

 

 
1

 
(1
)
International Segment

 
1

 
2

 

Luxury Segment

 
(6
)
 
(11
)
 
(8
)
Total segment equity in losses
$

 
$
(4
)
 
$
(7
)
 
$
(8
)
Other unallocated corporate
(1
)
 
2

 
(3
)
 
2

 
$
(1
)
 
$
(2
)
 
$
(10
)
 
$
(6
)

Assets
 
 
At Period End
($ in millions)
September 7,
2012
 
December 30,
2011
North American Full-Service Segment
$
1,234

 
$
1,241

North American Limited-Service Segment
459

 
497

International Segment
1,011

 
1,026

Luxury Segment
1,029

 
931

Total segment assets
3,733

 
3,695

Other unallocated corporate
2,132

 
2,215

 
$
5,865

 
$
5,910


20



14.
Acquisitions and Dispositions

2012 Completed Acquisitions

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 the second quarter of 2012, we entered into a definitive agreement with Gaylord Entertainment Company ("Gaylord Entertainment") to acquire the Gaylord brand and hotel management company. On September 25, 2012, Gaylord Entertainment’s shareholders approved its conversion into a real estate investment trust. On October 1, 2012 ("the acquisition date"), after the end of the 2012 third quarter, we acquired the Gaylord brand and hotel management company for $210 million in cash and recognized $210 million in intangible assets at the acquisition date, primarily reflecting deferred contract acquisition costs. Gaylord Entertainment continues to own the existing Gaylord hotels following the acquisition and we have assumed management of these properties under the Gaylord Hotel brand under long-term management agreements. We added four hotels and 7,800 rooms to our North American full-service portfolio as part of this transaction. We also agreed to manage other attractions for Gaylord Entertainment including a showboat, golf course, saloon, and another hotel with approximately 300 rooms. We assumed management of the attractions on October 1, 2012 with the exception of the hotel which we expect we will begin managing on December 1, 2012.

2012 Completed Dispositions

During the 2012 third quarter, we completed the sale of an equity interest in a North American Limited-Service joint venture (formerly two joint ventures which were merged before the sale) and we amended certain provisions of the management agreements for the underlying hotel portfolio. As a result of this transaction, we received cash proceeds of $96 million, including $30 million of proceeds which is refundable over the term of the management agreements if the hotel portfolio does not meet certain quarterly hotel performance thresholds. To the extent the hotel portfolio meets the quarterly hotel performance thresholds, we will recognize the $30 million of proceeds over the remaining term of the management agreements as base fee revenue. In the 2012 third quarter, we recognized a gain of $41 million, which consisted of: (1) $20 million related to the recognition of gain we deferred in 2005 because we retained the equity interest following the original sale of land to one of the joint ventures and because there were contingencies associated with the 2005 transaction that expired with this sale; and (2) $21 million related to the gain on the sale of the equity interest. We also recognized base management fee revenue in the 2012 third quarter totaling $7 million, primarily that we deferred prior to the transaction.

In the 2012 second quarter, we completed the sale of our ExecuStay corporate housing business. Neither the sales price nor the gain we recognized was material to our results of operations and cash flows. The revenues, results of operations, assets, and liabilities of our ExecuStay business also were not material to the Company's financial position, results of operations or cash flows for any of the periods presented, and accordingly we have not reflected ExecuStay as a discontinued operation.

15.
Variable Interest Entities
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

21


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 September 7, 2012, we managed six 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 three 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 three of the six hotels if there are cash flow shortfalls. Future minimum lease payments through the end of the lease term for these hotels totaled approximately $13 million at the end of the 2012 third quarter. In addition, as of the end of the 2012 third quarter we are liable for rent payments of up to an aggregate cap of $11 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.

16.
Spin-off
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 after the spin-off (by virtue of the license and other agreements between us and MVW), our former Timeshare segment's historical financial results for periods before 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.
Prior to the spin-off, in preparing our former Timeshare segment to operate as an independent, publicly traded company, management approved a plan in the 2011 third quarter for our former Timeshare segment to accelerate cash flow through the monetization of certain excess undeveloped land and to accelerate sales of excess built luxury fractional and residential inventory. As a result, in accordance with the guidance for accounting for the impairment or disposal of long-lived assets, we recorded a pre-tax non-cash impairment charge of $324 million ($234 million after-tax) in our 2011 third quarter Income Statements under the "Timeshare strategy-impairment charges" caption because the nominal cash flows from the planned land sales and the estimated fair values of the land and excess built luxury inventory were less than their respective carrying values. We estimated the fair values of the land and the excess built luxury inventory using Level 3 inputs. Please see Footnote No. 18, "Timeshare Strategy-Impairment Charges" of the Notes to our Financial Statements in our 2011 Form 10-K for additional information on these charges.


22


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

Forward-Looking Statements
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

Lodging Business

Our lodging business model primarily involves managing and franchising hotels, rather than owning them. At September 7, 2012, we operated 43 percent of the hotel rooms in our worldwide system under management agreements, our franchisees operated 54 percent under franchise agreements, we owned or leased 2 percent, and unconsolidated joint ventures that we have an interest in held management and franchise agreements for 1 percent.

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 minimizing financial leverage and risk in a cyclical industry. In addition, we believe we maintain our financial flexibility by minimizing our capital investments and adopting a strategy of recycling the investments that we make.

We earn base management fees and in some cases incentive management fees from the hotels that we manage, and we earn franchise fees on the hotels that others operate 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.
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 costs at company-operated properties as well as costs above-property. 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 strive to effectively leverage our size and broad distribution. 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 address, through various means, hotels in the system that do not meet 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.


23


Our profitability, as well as that of owners and franchisees, has benefited from our approach to property-level and above-property productivity. 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.

Lodging Performance Measures

We consider Revenue per Available Room ("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. We calculate constant dollar statistics by applying exchange rates for the current period to the prior comparable period.

We also consider company-operated house profit margin, which is the ratio of property-level gross operating profit (also known as house profit) to total property-level revenue, 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.

Lodging Results
Conditions for our lodging business continued to improve in the first three quarters 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. During this period, most markets in North and South America and Mexico experienced strong demand. However, some markets, particularly the greater Washington D.C. market experienced weak demand. In the greater Washington, D.C. market and particularly in the surrounding suburban markets, government spending restrictions reduced lodging demand as did a shorter congressional calendar earlier in 2012. The D.C. market also experienced customarily lower demand levels in 2012 associated with an election year, although leisure and group business were strong in the summer months. Economic growth in Europe was moderate during the first three quarters of 2012; reflecting strong demand in most international gateway cities, but weaker demand in markets dependent on more regional demand. In the 2012 third quarter, the business benefited from the Olympic Games in London and the Euro Cup Soccer Championship in Warsaw. In the first three quarters of 2012, demand was strong in the United Arab Emirates, but remained weak in Egypt, Jordan, Kuwait, and Oman. Demand in the Asia Pacific region continued to be strong in the first three quarters of 2012 particularly for properties in Thailand and China. Demand in China in the 2012 second and third quarters moderated somewhat as compared to the 2012 first quarter, particularly reflecting declines in government related travel ahead of the upcoming change in leadership there, moderating economic growth, and new supply in several markets. Lodging demand in gateway cities in China remained strong. RevPAR in India softened throughout 2012, reflecting the country's challenging economic environment and increased supply.

In the third quarter of 2012, as compared to the year ago quarter, worldwide average daily rates increased 4.7 percent on a constant dollar basis to $134.59 for comparable systemwide properties, with RevPAR increasing 6.0 percent to $100.40 and occupancy increasing 0.9 percentage points to 74.6 percent. For the first three quarters of 2012, as compared to the first three quarters of 2011, worldwide average daily rates increased 4.2 percent on a constant dollar basis to $136.51 for comparable systemwide properties, with RevPAR increasing 6.5 percent to $97.89 and occupancy increasing 1.6 percentage points to 71.7 percent.

We monitor market conditions and carefully price our rooms daily to meet individual hotel demand levels. We also modify the mix of our business to increase revenue as demand changes. Demand for higher rated rooms

24


continued to improve in most markets in the first three quarters of 2012, which allowed us to reduce discounting and special offers for transient business in many markets. This mix improvement benefited average daily rates. Our company-operated properties continuously monitor costs as we focus on enhancing property-level house profit margins and actively pursuing productivity improvements.

The hotels in our system serve both transient and group customers. Overall, business transient and leisure transient demand was strong in the first three quarters of 2012. Group demand remained strong in the first three quarters of 2012 and the group revenue booking pace for comparable North American Marriott Hotels & Resorts properties for the remainder of 2012 is up nearly 9 percent year-over-year. For 2013, group revenue booking pace for those properties is up over 7 percent with nearly 4 percent improvement in room rates over a strong 2012. Typically, two-thirds of group business is booked before 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 replaced with bookings reflecting generally higher rates. In the first three quarters of 2012, 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 first three quarters of 2012, and attendance at meetings frequently exceeded initial projections. In the 2012 third quarter, the booking window lengthened as meeting planners reserved meeting and guest room space further in advance to ensure availability.

Lodging System Growth and Pipeline

During the first three quarters of 2012, we added 13,166 rooms (gross) to our system. Approximately 42 percent of new rooms are located outside the United States and 28 percent of the room additions are conversions from competitor brands. At the end of the 2012 third quarter, we had over 120,000 rooms in our lodging development pipeline, which does not include the five hotels (approximately 8,100 rooms) from our acquisition of the Gaylord brand and hotel management company, which we completed early in the 2012 fourth quarter. For the full 2012 fiscal year, we expect to add approximately 28,000 rooms (gross) to our system, including 8,100 rooms from the Gaylord transaction. See the following paragraph for additional information regarding the Gaylord transaction. During the first three quarters of 2012, construction delays in Asia, the Middle East, and Mexico have pushed some hotel openings that were expected in 2012 into 2013. We expect approximately 10,000 rooms to exit the system during the 2012 full fiscal year, largely due to financial and quality issues. For the 2013 fiscal year, we expect to add 30,000 to 35,000 rooms (gross) to our system. The figures in this paragraph do not include residential, timeshare, or ExecuStay units.

Lodging Transactions
In the second quarter of 2012, we entered into a definitive agreement with Gaylord Entertainment Company ("Gaylord Entertainment") to acquire the Gaylord brand and hotel management company. On October 1, 2012, after the end of the 2012 third quarter, we acquired the Gaylord brand and hotel management company for $210 million. Gaylord Entertainment continues to own the existing Gaylord hotels and we assumed management of these properties under the Gaylord Hotel brand subject to long-term management agreements. We added four hotels and approximately 7,800 rooms to our North American full-service portfolio on October 1, 2012 as part of this transaction. In addition, we agreed to manage four other attractions for Gaylord Entertainment, including another hotel with approximately 300 rooms. We assumed management of the attractions on October 1, 2012 with the exception of the hotel which we expect we will begin managing on December 1, 2012.
Also in the 2012 second quarter, we completed the sale of our ExecuStay corporate housing business. Neither the sales price nor the gain we recognized was material to our results of operations and cash flows. The revenues, results of operations, assets, and liabilities of our ExecuStay business also were not material to our financial position, results of operations or cash flows for any of the periods presented, and accordingly we have not reflected ExecuStay as a discontinued operation.
During the 2012 third quarter, we completed the sale of an equity interest in a North American Limited-Service joint venture and we amended certain provisions of the management agreements for the underlying hotel

25


portfolio. As a result of this transaction we received cash proceeds of $96 million, including $30 million of proceeds which is refundable over the term of the management agreements if the hotel portfolio does not meet certain quarterly hotel performance thresholds. To the extent the hotel portfolio meets the quarterly hotel performance thresholds, we will recognize the $30 million of proceeds over the remaining term of the management agreements as base fee revenue. In the 2012 third quarter, we recognized a gain of $41 million, which consisted of: (1) $20 million related to the recognition of gain we deferred in 2005 because we retained the equity interest following the original sale of land to one of the joint ventures and because there were contingencies associated with the 2005 transaction that expired with this sale; and (2) $21 million related to the gain on the sale of the equity interest. We also recognized base management fee revenue in the 2012 third quarter totaling $7 million, primarily that we deferred prior to the transaction.
See Footnote No. 14 "Acquisitions and Dispositions" of the Notes to our Financial Statements in this Form 10-Q for more information on these lodging transactions.

Timeshare Spin-off and Timeshare Strategy-Impairment Charges

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"). We now earn license fees from MVW under 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 operations after the spin-off (by virtue of the license and other agreements between us and MVW), we continue to include the historical financial results before the spin-off of our former Timeshare segment 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.
As further detailed in Footnote No. 16, "Spin-off" of this Form 10-Q, prior to the spin-off we recorded a pre-tax non-cash impairment charge of $324 million ($234 million after-tax) in our 2011 third quarter Income Statements under the “Timeshare strategy-impairment charges” caption.

26




CONSOLIDATED RESULTS

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 include in "other unallocated corporate." The following tables detail the components of our former Timeshare segment revenues and results as well as certain items that we did not allocate to our Timeshare segment for the twelve and thirty-six weeks ended September 9, 2011 and also shows the components of revenue, interest income and interest expense we received from MVW for the twelve and thirty-six weeks ended September 7, 2012.
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
($ in millions)
September 7,
2012
 
September 9,
2011
 
Change
2012/2011
 
September 7,
2012
 
September 9, 2011
 
Change
2012/2011
Former Timeshare segment revenues
 
 
 
 
 
 
 
 
 
 
 
Base fee revenue
$

 
$
14

 
 
 
$

 
$
40

 
 
Total sales and services revenue

 
286

 
 
 

 
850

 
 
Cost reimbursements

 
77

 
 
 

 
235

 
 
Former Timeshare segment revenues

 
377

 
$
(377
)
 

 
1,125

 
$
(1,125
)
 
 
 
 
 
 
 
 
 
 
 
 
Other base fee revenue

 
2

 
(2
)
 

 
4

 
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
Other unallocated corporate revenues from MVW
 
 
 
 
 
 
 
 
 
 
 
Franchise fee revenue
15

 

 
 
 
42

 

 
 
Cost reimbursements
33

 

 
 
 
93

 

 
 
 Revenues from MVW
48

 

 
48

 
135

 

 
135

 
 
 
 
 
 
 
 
 
 
 
 
Total revenue impact
$
48

 
$
379

 
$
(331
)
 
$
135

 
$
1,129

 
$
(994
)
 
 
 
 
 
 
 
 
 
 
 
 

27


 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
 
September 7,
2012
 
September 9,
2011
 
Change
2012/2011
 
September 7,
2012
 
September 9, 2011
 
Change
2012/2011
Former Timeshare segment results operating income impact
 
 
 
 
 
 
 
 
 
 
 
Base fee revenue
$

 
$
14

 
 
 
$

 
$
40

 
 
Timeshare sales and services, net

 
36

 
 
 

 
130

 
 
Timeshare strategy-impairment charges

 
(324
)
 
 
 

 
(324
)
 
 
General, administrative, and other expense

 
(17
)
 
 
 

 
(50
)
 
 
Former Timeshare segment results operating income impact 1

 
(291
)
 
$
291

 

 
(204
)
 
$
204

 
 
 
 
 
 
 
 
 
 
 
 
Other base fee revenue

 
2

 
(2
)
 

 
4

 
(4
)
General, administrative, and other expenses
 
 
 
 
 
 
 
 
 
 
 
Timeshare spin-off costs

 
(8
)
 
8

 

 
(12
)
 
12

Other miscellaneous expenses

 
(2
)
 
2

 

 
(2
)
 
2

 
 
 
 
 
 
 
 
 
 
 
 
Other Unallocated corporate operating income impact from MVW
 
 
 
 
 
 
 
 
 
 
 
Franchise fee revenue
15

 

 
15

 
42

 

 
42

 
 
 
 
 
 
 
 
 
 
 
 
Total operating income (loss) impact
15

 
(299
)
 
314

 
42

 
(214
)
 
256

Gains (losses) and other income 1

 
(1
)
 
1

 

 

 

Interest expense 1
(2
)
 
(10
)
 
8

 
(6
)
 
(34
)
 
28

Capitalized interest

 
2

 
(2
)
 

 
5

 
(5
)
Interest income
3

 

 
3

 
8

 

 
8

Equity in earnings (losses) 

 
4

 
(4
)
 

 
4

 
(4
)
Income (loss) before income taxes spin-off impact
$
16

 
$
(304
)
 
$
320

 
$
44

 
$
(239
)
 
$
283

1 Timeshare segment results for the twelve weeks ended September 9, 2011 totaled a loss of $302 million and consisted of $291 million of operating losses, $10 million of interest expense, and $1 million of other losses. Timeshare segment results for the thirty-six weeks ended September 9, 2011 totaled a loss of $238 million and consisted of $204 million of operating losses and $34 million of interest expense.

The following discussion presents an analysis of results of our operations for the twelve and thirty-six weeks ended September 7, 2012, compared to the twelve and thirty-six weeks ended September 9, 2011. The results for the first three quarters of 2011 include the results of the former Timeshare segment.
Revenues
Twelve Weeks. Revenues decreased by $145 million (5 percent) to $2,729 million in the third quarter of 2012 from $2,874 million in the third quarter of 2011. As detailed in the preceding table, the spin-off contributed to a net $331 million decrease in revenues that was partially offset by a $186 million increase in revenues in our lodging

28


business.

The $186 million increase in revenues for our lodging business was a result of: higher cost reimbursements revenue ($209 million), higher base management fees ($14 million), higher franchise fees ($10 million), and higher incentive management fees ($7 million (comprised of a $4 million increase for North America and a $3 million increase outside of North America)), partially offset by lower owned, leased, corporate housing, and other revenue ($54 million (which includes a $29 million reduction associated with our sold corporate housing business as further discussed below)).
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 $165 million increase in total cost reimbursements revenue, to $2,210 million in the 2012 third quarter from $2,045 million in the 2011 third quarter, reflected a $209 million increase (allocated across our lodging business) as a result of the impact of higher property-level demand and growth across the system, partially offset by a net $44 million decline in timeshare-related cost reimbursements due to the spin-off. Since the end of the 2011 third quarter, our managed rooms decreased by 1,819 rooms net of hotels added to our system, primarily due to conversions to franchised rooms. We added 11,800 franchised rooms to our system, net of hotels exiting the system, since the end of the 2011 third quarter.
The $2 million decrease in total base management fees, to $134 million in the 2012 third quarter from $136 million in the 2011 third quarter, primarily reflected a decline of $16 million in former Timeshare segment and previously unallocated base management fees due to the spin-off, partially offset by a net increase of $14 million across our lodging business primarily as a result of stronger RevPAR ($6 million) as well as the recognition in the 2012 third quarter of $7 million of previously deferred base management fees in conjunction with the sale of our equity interest in a North American-Limited Service joint venture. The $25 million increase in total franchise fees, to $149 million in the 2012 third quarter from $124 million in the 2011 third quarter, primarily reflected an increase of $15 million in MVW license fees due to our arrangement with MVW that we entered into in connection with the spin-off and an increase of $10 million across our lodging business primarily as a result of stronger RevPAR ($6 million) and the impact of unit growth across the system ($3 million). The $7 million increase in incentive management fees from $29 million in the third quarter of 2011 to $36 million in the third quarter of 2012 primarily reflected higher net property-level income resulting from higher property-level revenue as well as recognition of $3 million of incentive management fees due to contract revisions for certain International segment properties, partially offset by the timing of fee recognition for two Luxury segment properties that earned incentive fees in the 2012 first, second, and third quarters as compared to just the 2011 third quarter in the prior year ($3 million) and unfavorable foreign exchange rates ($2 million). The increase in incentive management fees also reflected continued property-level cost controls and, to a lesser extent, new unit growth in international markets.
The $54 million decrease in owned, leased, corporate housing, and other revenue, to $200 million in the 2012 third quarter, from $254 million in the 2011 third quarter, primarily reflected $29 million of lower corporate housing revenue due to the sale of the ExecuStay corporate housing business in the 2012 second quarter, $18 million of lower owned and leased revenue, $7 million of lower hotel agreement termination fees, and $3 million of lower branding fees. The $18 million decrease in owned and leased revenue primarily reflected $6 million of lower revenue at a property that converted from leased to managed at year-end 2011 and $14 million of lower revenue at several owned and leased properties in our International segment, primarily driven by two hotels that left the system, unfavorable foreign exchange rates, and weaker demand at two other hotels. These decreases were partially offset by $6 million of increased revenue at our leased property in London due to strong demand, in part associated with the third quarter 2012 Olympic Games. Combined branding fees associated with card endorsements and the sale of branded residential real estate by others totaled $26 million and $29 million for the 2012 and 2011 third quarters, respectively.

29



Thirty-six Weeks. Revenues decreased by $567 million (7 percent) to $8,057 million in the first three quarters of 2012 from $8,624 million in the first three quarters of 2011. As detailed in the preceding table, the spin-off contributed to a net $994 million decrease in revenues that was partially offset by a $427 million increase in revenues in our lodging business.

The $427 million increase in revenues for our lodging business was a result of: higher cost reimbursements revenue ($397 million), higher franchise fees ($31 million), higher base management fees ($24 million), and higher incentive management fees ($21 million (comprised of a $10 million increase for North America and an $11 million increase outside of North America)), partially offset by lower owned, leased, corporate housing, and other revenue ($46 million (which includes a $35 million reduction associated with our sold corporate housing business as further discussed below)).
The $255 million increase in total cost reimbursements revenue, to $6,415 million in the first three quarters of 2012 from $6,160 million in the first three quarters of 2011, reflected a $397 million increase (allocated across our lodging business) as a result of the impact of higher property-level demand and growth across the system, partially offset by a net $142 million decline in timeshare-related cost reimbursements due to the spin-off.
The $20 million decrease in total base management fees, to $399 million in the first three quarters of 2012 from $419 million in the first three quarters of 2011, primarily reflected a decline of $44 million in former Timeshare segment and previously unallocated base management fees due to the spin-off, partially offset by a net increase of $24 million across our lodging business. The $24 million net increase in base management fees across our lodging business primarily reflected stronger RevPAR ($19 million) and the impact of unit growth across the system ($4 million), as well as the recognition in the 2012 third quarter of $7 million of previously deferred base management fees in conjunction with the sale of our equity interest in a North American-Limited Service joint venture, partially offset by the unfavorable impact of $3 million of fee reversals in the first three quarters of 2012 for two properties to reflect contract revisions and unfavorable foreign exchange rates ($2 million). The $73 million increase in total franchise fees, to $420 million in the first three quarters of 2012 from $347 million in the first three quarters of 2011, primarily reflected an increase of $42 million in MVW license fees due to our arrangement with MVW that we entered into in connection with the spin-off and an increase of $31 million across our lodging business primarily as a result of stronger RevPAR ($20 million) and the impact of unit growth across the system ($9 million). The $21 million increase in incentive management fees from $121 million in the first three quarters of 2011 to $142 million in the first three quarters of 2012 primarily reflected higher net property-level income resulting from higher property-level revenue as well as recognition of $3 million of incentive management fees due to contract revisions for certain International segment properties, partially offset by unfavorable foreign exchange rates ($3 million). The increase in incentive management fees also reflected continued property-level cost controls and, to a lesser extent, new unit growth in international markets ($3 million).
The $46 million decrease in owned, leased, corporate housing, and other revenue, to $681 million in the first three quarters of 2012, from $727 million in the first three quarters of 2011, primarily reflected $35 million of lower corporate housing revenue due to the sale of the ExecuStay corporate housing business in the 2012 second quarter, and $20 million of lower owned and leased revenue, partially offset by $6 million of higher branding fees and $4 million of higher other revenue. The $20 million decrease in owned and leased revenue primarily reflected: (1) $17 million of lower revenue at a property that converted from leased to managed at year-end 2011; and (2) $26 million of lower revenue at several owned and leased properties in our International segment, primarily driven by two hotels that left the system, weaker demand at two other hotels, and unfavorable foreign exchange rates; partially offset by (3) $13 million of higher revenue at our leased property in London due to strong demand, in part associated with the 2012 third quarter Olympic Games; and (4) $12 million of higher revenue at our leased property in Japan. The property in Japan benefited from favorable comparisons with 2011 as a result of very weak demand due to the earthquake and tsunami as well as a $2 million business interruption payment received in the 2012 second quarter from a utility company. Combined branding fees associated with card endorsements and the sale of branded residential real estate by others totaled $69 million and $63 million for the first three quarters of 2012 and 2011, respectively.

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Operating Income (Loss)
Twelve Weeks. Operating income increased by $357 million to operating income of $213 million in the 2012 third quarter from an operating loss of $144 million in the 2011 third quarter. The $357 million increase in operating income reflected a net $314 million favorable variance in operating income due to the spin-off (which included $324 million of Timeshare strategy-impairment charges in the 2011 third quarter) as detailed in the preceding table and a $43 million increase in operating income across our lodging business. The $43 million increase across our lodging business reflected a $21 million decrease in general, administrative and other expenses, a $14 million increase in base management fees, a $10 million increase in franchise fees, and a $7 million increase in incentive management fees, partially offset by $9 million of lower owned, leased, corporate housing, and other revenue net of direct expenses. We discuss the reasons for the increases in base management fees, franchise fees, and incentive management fees across our lodging business compared to the 2011 third quarter in the preceding “Revenues” section.
The $9 million (26 percent) decrease in owned, leased, corporate housing, and other revenue net of direct expenses was primarily attributable to $7 million of lower hotel agreement termination fees, $3 million of lower branding fees, and $1 million of net weaker results at some owned and leased properties. Weaker net results at some of our owned and leased properties were primarily driven by lower property-level margins and were partially offset by stronger results at our leased property in London due to strong demand and higher property-level margins.
General, administrative, and other expenses decreased by $48 million (27 percent) to $132 million in the third quarter of 2012 from $180 million in the third quarter of 2011. The decrease reflected a $21 million decrease across our lodging business and a decrease of $27 million due to the spin-off (consisting of $17 million of former Timeshare segment general, administrative, and other expenses and $10 million of other expenses not previously allocated to the former Timeshare segment including $8 million of Timeshare spin-off costs and $2 million of other expenses.) The $21 million decrease across our lodging business was primarily a result of: (1) favorable variances from the following 2011 third quarter items: (a) $5 million impairment of deferred contract acquisition costs and a $5 million accounts receivable reserve, both related to one Luxury segment property whose owner filed for bankruptcy; and (b) $5 million related to a guarantee reserve for one North American Full-Service property and the write-off of contract acquisition costs; and (2) the following favorable third quarter 2012 items: (a) a favorable litigation settlement, partially offset by higher legal expenses, netting to a favorable $5 million; and (b) $4 million of guarantee reserve reversals; partially offset by (3) the following unfavorable third quarter 2012 items: (a) a $3 million guarantee reserve for an International segment property primarily due to cash flow shortfalls at the property; and (b) $2 million of increased compensation and other overhead expenses.
The $21 million decrease in total general, administrative, and other expenses across our lodging business consisted of a $13 million decrease allocated to our Luxury segment, an $8 million decrease that we did not allocate to any of our segments, and a $3 million decrease allocated to our North American Limited-Service segment, partially offset by a $3 million increase allocated to our International segment.

Thirty-six Weeks. Operating income increased by $352 million to $631 million in the first three quarters of 2012 from $279 million in the first three quarters of 2011. The $352 million increase in operating income reflected a net $256 million favorable variance in operating income due to the spin-off, as detailed in the preceding table, and a $96 million increase in operating income across our lodging business. This $96 million increase reflected a $31 million increase in franchise fees, $25 million of higher owned, leased, corporate housing, and other revenue net of direct expenses, a $24 million increase in base management fees, and a $21 million increase in incentive management fees, 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 compared to the first three quarters of 2011 in the preceding “Revenues” section.
The $25 million (30 percent) increase in owned, leased, corporate housing, and other revenue net of direct expenses was primarily attributable to $15 million of net stronger results particularly at our leased property in Japan

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($8 million) and our leased property in London ($8 million), $6 million of higher branding fees, and $4 million of higher other revenue. Our leased property in London benefited from strong demand and higher property-level margins in the 2012 second and third quarters, while our leased property in Japan experienced particularly strong demand in the 2012 second quarter, benefiting from favorable comparisons with 2011 as a result of very weak demand due to the earthquake and tsunami as well as a $2 million business interruption payment received in the 2012 second quarter from a utility company.
General, administrative, and other expenses decreased by $59 million (12 percent) to $439 million in the first three quarters of 2012 from $498 million in the first three quarters of 2011. The $59 million decrease reflected a decline of $64 million due to the spin-off (consisting of $50 million of former Timeshare segment general, administrative, and other expenses and $14 million of other expenses not previously allocated to the former Timeshare segment including $12 million of Timeshare spin-off costs and $2 million of other expenses), partially offset by an increase of $5 million across our lodging business. The $5 million increase across our lodging business was primarily a result of: (1) the following unfavorable 2012 items: (a) $12 million of increased compensation and other overhead expenses; (b) the accelerated amortization of $8 million of deferred contract acquisitions costs related to a North American Full-Service segment property (for which we earned a termination fee that we recorded in owned, leased, corporate housing, and other revenue); and (c) $6 million of guarantee reserves associated with two International segment properties; and (2) the unfavorable variance for a $5 million reversal in 2011 of a loan loss provision related to one property with increased expected future cash flows; partially offset by (3) favorable variances from the following 2011 items: (a) a $5 million impairment of deferred contract acquisition costs and a $5 million accounts receivable reserve, both related to one Luxury segment property whose owner filed for bankruptcy; (b) a $5 million performance cure payment for a North American Full-Service property; and (c) a $4 million guarantee reserve for one North American Full-Service property and the write-off of contract acquisition costs; and (4) a favorable $4 million of guarantee reserve reversals in 2012. See our discussion under the "North American Full-Service Lodging" caption for additional information on the termination fee and the related accelerated amortization of deferred contract acquisition costs recorded in 2012.
The $5 million increase in total general, administrative, and other expenses across our lodging business consisted of an $8 million increase that we did not allocate to any of our segments and an $8 million increase allocated to our International segment, partially offset by a $10 million decrease allocated to our Luxury segment and a $1 million decrease allocated to our North American Limited-Service segment.

Gains (Losses) and Other Income
We show our gains and other income for the twelve and thirty-six weeks ended September 7, 2012, and September 9, 2011 in the following table:
 
Twelve Weeks Ended
 
Thirty-Six Weeks Ended
($ in millions)
September 7,
2012
 
September 9,
2011
 
September 7,
2012
 
September 9,
2011
Gains on sales of real estate and other
$
22

 
$
2

 
$
26

 
$
7

Gain on sale of joint venture and other investments
21

 

 
21

 

Income from cost method joint ventures

 

 
3

 

Impairment of cost method joint venture investment and equity securities
(7
)
 
(18
)
 
(7
)
 
(18
)
 
$
36

 
$
(16
)
 
$
43

 
$
(11
)
Twelve Weeks. In the 2012 third quarter, we recognized a total gain of $41 million on the sale of an equity interest in a North American Limited-Service joint venture (formerly two joint ventures which were merged before the sale) which consisted of: (1) a $21 million gain on the sale of this interest reflected in the "Gain on sale of joint venture and other investments" caption above; and (2) recognition of the $20 million remaining gain we deferred in 2005 due to contingencies in the original transaction documents associated with the sale of land to one of the joint ventures, reflected in the "Gains on sales of real estate and other" caption above. See Footnote No. 14, "Acquisitions and Dispositions" for additional information on the sale of this equity interest.

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The "Impairment of cost method joint venture investment and equity securities" line in the table above reflects the other-than-temporary impairment of a cost method joint venture investment in the 2012 third quarter ($7 million) and marketable equity securities in the 2011 third quarter ($18 million). For additional information on the impairments, see Footnote No. 5, “Fair Value of Financial Instruments.”
Thirty-six Weeks. In the first three quarters of 2012, we recognized a total gain of $41 million on the sale of an equity interest in a North American Limited-Service joint venture which consisted of a $21 million gain reflected in the "Gain on sale of joint venture and other investments" caption above and recognition of a $20 million deferred gain in the "Gains on sales of real estate and other" caption above as noted in the preceding "Twelve Weeks" discussion.
See the "Twelve Weeks" discussion for additional information on the "Impairment of cost method joint venture investment and equity securities" line in the table above.

Interest Expense
Twelve Weeks. Interest expense decreased by $10 million (26 percent) to $29 million in the third quarter of 2012 compared to $39 million in the third quarter of 2011. This decrease reflected a $6 million decrease due to the spin-off and a $4 million decrease for our lodging business. The $6 million decrease in interest expense due to the spin-off consisted of interest expense in the 2011 third quarter that was allocated to the former Timeshare segment ($10 million), partially offset by interest expense in 2012 for on-going obligations for which the costs were a component of "Timeshare - direct" expenses prior to the spin-off ($2 million) and the unfavorable variance to 2011 for capitalized interest expense associated with construction