Financial Information

PART II

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

BUSINESS AND OVERVIEW

Overview

We are a worldwide operator, franchisor, and licensor of hotels and timeshare properties in 87 countries and territories under 19 brand names. We also develop, operate, and market residential properties and provide services to home/condominium owner associations. Under our business model, we typically manage or franchise hotels, rather than own them. We group our operations into three business segments: North American Full-Service, North American Limited-Service, and International.

We earn base management fees and in many cases incentive management fees from the properties that we manage, and we earn franchise fees on the properties that others operate under franchise agreements with us. Base fees typically consist of a percentage of property-level revenue while incentive fees typically consist of 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, and capital spending reserves.

Our emphasis on long-term management contracts and franchising tends to provide more stable earnings in periods of economic softness, while adding new hotels to our system generates growth, typically with little or no investment by the Company. This strategy has driven substantial growth while minimizing financial leverage and risk in a cyclical industry. In addition, we believe minimizing our capital investments and adopting a strategy of recycling the investments that we do make maximizes and maintains our financial flexibility.

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 both at company-operated properties and at the corporate level (“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 our system that do not meet standards. We continue to enhance the appeal of our proprietary, information-rich, and easy-to-use website, Marriott.com, and of our associated mobile smartphone applications and mobile website that connect to 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.

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.

Pending Combination with Starwood Hotels & Resorts Worldwide, Inc.

On November 15, 2015, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) to combine with Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”). The Merger Agreement provides for the Company to combine with Starwood in a series of transactions after which Starwood will be an indirect wholly owned subsidiary of the Company (the “Starwood Combination”). If these transactions are completed, shareholders of Starwood will receive 0.920 shares of our Class A Common Stock, par value $0.01 per share, and $2.00 in cash, without interest, for each share of Starwood common stock, par value $0.01 per share, that they own immediately before these transactions. We expect that the combination will close in mid-2016, after customary conditions are satisfied, including shareholder approvals, required antitrust approvals, and the completion of Starwood's previously announced spin-off of its vacation ownership business, or another spin-off, split-off, analogous disposition, or sale of its vacation ownership business.

Performance Measures

We believe Revenue per Available Room (“RevPAR”), which we calculate by dividing room sales for comparable properties by room nights available for the period, is 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. We also believe occupancy and average daily rate (“ADR”), which are components of calculating RevPAR, are meaningful indicators of our performance. Occupancy, which we calculate by dividing occupied rooms by total rooms available, measures the utilization of a property's available capacity. ADR, which we calculate by dividing property room revenue by total rooms sold, measures average room price and is useful in assessing pricing levels.

References to year-end 2015 RevPAR statistics throughout this report, including occupancy and ADR, reflect the twelve months ended December 31, 2015, as compared to the twelve months ended December 31, 2014. For the properties located in countries that use currencies other than the U.S. dollar, the comparisons to the prior year period are on a constant U.S. dollar basis. We calculate constant dollar statistics by applying exchange rates for the current period to the prior comparable period.

We define our comparable properties as those that were open and operating under one of our brands since the beginning of the last full calendar year (since January 1, 2014 for the current period), and have not, in either the current or previous year: (i) undergone significant room or public space renovations or expansions, (ii) been converted between company-operated and franchised, or (iii) sustained substantial property damage or business interruption. Comparable properties represented the following percentages of our properties for each year indicated: (1) 86% of North American properties (87% excluding Delta Hotels and Resorts) in 2015, 87% in 2014, and 89% in 2013; (2) 57% of International properties (68% excluding Protea Hotels) in 2015, 57% (71% excluding Protea Hotels) in 2014, and 75% in 2013; and (3) 82% of total properties (85% excluding Protea Hotels and Delta Hotels and Resorts) in 2015, 82% of total properties (85% excluding Protea Hotels) in 2014, and 87% in 2013.

We also believe company-operated house profit margin, which is the ratio of property-level gross operating profit to total property-level revenue, is 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.

Business Trends

Our 2015 results reflected a favorable economic climate and demand for our brands in many markets around the world, reflecting generally low supply growth in the U.S. and Europe, moderate GDP growth in North America, improved pricing in most North American markets, and a year-over-year increase in the number of properties in our system. Comparable worldwide systemwide RevPAR for 2015 increased 5.2 percent to $112.25, average daily rates increased 4.1 percent on a constant dollar basis to $152.30, and occupancy increased 0.8 percentage points to 73.7 percent, compared to 2014.

Generally strong U.S. group business and transient demand contributed to increased room rate growth in 2015, allowing us to eliminate discounts, shift business into higher rated price categories, and raise room rates. The growth was partially constrained by new select-service lodging supply and moderating GDP growth late in the year.

In 2015, bookings for future group business in the U.S. improved. New group business booked in 2015 for any period in the future increased 9 percent year over year. The 2016 group revenue pace for systemwide full-service hotels (Marriott, JW Marriott, Renaissance, The Ritz-Carlton, and Gaylord brands) in North America was up more than 6 percent as of year-end 2015, compared to the 2015 group booking pace measured as of year-end 2014. In North America, RevPAR from transient guests increased 5 percent in 2015 reflecting strong demand from professional services, technology, and defense firms moderated somewhat by weaker demand from manufacturing, pharmaceutical, and energy companies.

The Europe region experienced higher demand in 2015 across most countries, primarily due to increased group and transient business driven by special events and the weak currency, partially constrained by weaker demand in France, particularly late in the year. Results improved in Russia due to increased domestic travel. In the Asia Pacific region, demand increased led by growth from corporate and other transient business in Japan, India, Thailand, and Indonesia. The growth was partially offset by weaker results in South Korea. RevPAR in Greater China moderated in 2015 due to the impact of supply growth in certain Southern China markets, continued austerity in Beijing, and lower inbound travel to Hong Kong, while demand in Shanghai remained strong. Middle East demand was weaker in 2015, reflecting the region's instability and lower oil prices, partially offset by strong government and group demand in Saudi Arabia. Demand in the United Arab Emirates was constrained mainly by new supply and, to a lesser extent, a reduction in travelers from Russia. In Africa, results were favorable in 2015. In the Caribbean and Latin America, strong performance in the region in 2015 was driven by greater demand in Mexico and increased leisure travel to our Caribbean and Mexican resorts for most of the year, constrained somewhat by oversupply of hotels in Panama and weaker economies in Brazil and Puerto Rico.

We monitor market conditions and provide the tools for our hotels to price rooms daily in accordance with individual property demand levels, generally adjusting room rates as demand changes. Our hotels modify the mix of business to improve revenue as demand changes. Demand for higher rated rooms improved in most markets in 2015, which allowed our hotels to reduce discounting and special offers for transient business in many markets. This mix improvement benefited ADR. For our company-operated properties, we continue to focus on enhancing property-level house profit margins and making productivity improvements.