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 hotel, residential, and timeshare properties in 130 countries and territories under 30 brand names. Under our asset-light business model, we typically manage or franchise hotels, rather than own them. We discuss our operations in the following reportable business segments: North American Full-Service, North American Limited-Service, and Asia Pacific. Our Europe, Middle East and Africa, and Caribbean and Latin America operating segments do not individually meet the criteria for separate disclosure as reportable segments.

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. In most markets, base management and franchise fees typically consist of a percentage of property-level revenue, or certain property-level revenue in the case of franchise fees, while incentive management fees typically consist of a percentage of net house profit after a specified owner return. In our Middle East and Africa and Asia Pacific regions, incentive management fees typically consist of a percentage of gross operating profit without adjustment for a specified owner return. Net house profit is calculated as gross operating profit (also referred to as “house profit,” which we discuss under the “Performance Measures” section below) 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 our investments 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”). We provide our guests new and memorable experiences through our portfolio of brands, innovative technology, personalized guest recognition, and access to travel experiences through our Marriott Bonvoy Moments program. Our brands remain strong due to our skilled management teams, dedicated associates, superior guest service with an emphasis on guest and associate satisfaction, significant distribution, our Loyalty Program, multichannel reservation systems, 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, technology offerings, and guest experiences. We address, through various means, hotels in our system that do not meet our standards. We continue to enhance the appeal of our proprietary, information-rich, and easy-to-use websites, and of our associated mobile smartphone applications, through functionality and service improvements.

Our profitability, as well as that of owners and franchisees, has benefited from our approach to property-level and above-property productivity. Managed properties in our system continue to maintain 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.

Data Security Incident

On November 30, 2018, we announced a data security incident involving unauthorized access to the Starwood reservations database (the “Data Security Incident”). Working with leading security experts, we determined that there was unauthorized access to the Starwood network since 2014 and that an unauthorized party had copied information from the Starwood reservations database and taken steps towards removing it. The information copied from the Starwood reservations database over time included information about guests who made a reservation at a Starwood property, including names, mailing addresses, phone numbers, email addresses, passport numbers, payment card numbers and expiration dates, Starwood Preferred Guest account information, dates of birth, gender, arrival and departure information, reservation dates, and communication preferences. The combination of information varied by guest. Based on our analysis as of the date of this filing, we believe that the upper limit for the total number of guest records involved in this incident is approximately 383 million records. In many instances, there appear to be multiple records for the same guest, so we have concluded with a fair degree of certainty that information for fewer than 383 million unique guests was involved, although we are currently unable to quantify that lower number because of the nature of the data in the database. Based on our analysis as of the date of this filing, we believe that the information accessed by an unauthorized third party included approximately 5.25 million unencrypted passport numbers, approximately 18.5 million encrypted passport numbers and approximately 9.1 million encrypted payment card numbers (approximately 385,000 of which cards were unexpired as of September 2018). Certain data analytics work continues, including by the investigative firm engaged on behalf of the payment card networks, and based on the preliminary information we have as of the date of this filing, we believe that the information accessed by an unauthorized third party could include several thousand unencrypted payment card numbers.

Upon receiving information that an alert from an internal security tool was related to an attempt to access the Starwood reservations database, we quickly engaged leading security experts to conduct a comprehensive forensic review to determine the scope of the intrusion, including the specific data impacted, and assist with containment measures. While that forensic review of the incident is now complete, certain data analytics work continues. We reported this incident to law enforcement and continue to support their investigation. We have completed the planned phase out of the operation of the Starwood reservations database, effective as of the end of 2018.

Following the Data Security Incident, we began a guest outreach effort and offered certain services to help guests monitor and protect their information. Promptly following our announcement of the incident, we began sending emails on a rolling basis directly to various Starwood guests whose email addresses were in the Starwood reservations database, and we completed sending these emails on December 21, 2018. We also established a multi-language dedicated website and multi-language call center to answer guests’ questions about the incident. The dedicated website provides guests details of the incident, the information affected, the steps being taken to investigate, FAQs and information about how guests can monitor and protect their information. We are offering free web monitoring solutions for affected guests in certain jurisdictions where the monitoring services are available.

To date, we have not seen a meaningful impact on demand as a result of the Data Security Incident.

We are currently unable to estimate the range of total possible financial impact to the Company from the Data Security Incident. However, we do not believe this incident will impact our long-term financial health. We maintain insurance designed to limit our exposure to losses such as those related to the Data Security Incident. We expect that the cost of such insurance will increase significantly in 2019 and future years. We expect to incur significant expenses associated with the Data Security Incident in future periods, primarily related to legal proceedings and regulatory investigations, increased expenses and capital investments for IT and information security, incident response and customer care, and increased expenses for insurance, compliance activities, and to meet increased legal and regulatory requirements. See Footnote 7. Commitments and Contingencies for information related to expenses incurred in 2018, insurance recoveries, and legal proceedings and governmental investigations related to the Data Security Incident.

Performance Measures

We believe 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.

Our RevPAR statistics for 2018, 2017, and 2016, include Legacy-Starwood comparable properties for each of the full years even though Marriott did not own the Legacy-Starwood brands before the Merger Date. Therefore, our RevPAR statistics include Legacy-Starwood properties for periods during which fees from the Legacy-Starwood properties are not included in our Income Statements. We provide these RevPAR statistics as an indicator of the performance of our brands and to allow for comparison to industry metrics, and they should not be viewed as necessarily correlating with our fee revenue. 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 our properties, including those that we acquired through the Starwood Combination, that were open and operating under one of our Legacy-Marriott or Legacy-Starwood brands since the beginning of the last full calendar year (since January 1, 2017 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. For 2018 compared to 2017, we had 4,109 comparable North American properties and 1,173 comparable International properties. For 2017 compared to 2016, we had 3,883 comparable North American properties and 1,030 comparable International properties.

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 2018 full-year results reflected a year-over-year increase in the number of properties in our system, favorable demand for our brands in many markets around the world, and generally favorable economic conditions. Comparable worldwide systemwide RevPAR for 2018 increased 2.6 percent to $117.37, ADR increased 2.0 percent on a constant dollar basis to $160.37, and occupancy increased 0.4 percentage points to 73.2 percent, compared to 2017.

In North America, RevPAR increased in 2018, driven by both higher transient and group demand. RevPAR growth was partially constrained by new lodging supply in certain markets and comparisons to 2017 natural disasters. In our Asia Pacific segment in 2018, RevPAR grew in most markets, led by China, Indonesia and India. Our Europe region experienced higher demand in 2018, led by strong transient business in most countries and demand from the World Cup, partially constrained by lower RevPAR in Spain. In our Middle East and Africa region, RevPAR decreased due to geopolitical instability and supply growth in the Middle East, partially offset by strong growth in Africa. RevPAR grew across our Caribbean and Latin America region, driven by higher ADR, partially due to lower supply following 2017 hurricane activity in the Caribbean.

For our company-operated properties, we continue to focus on enhancing property-level house profit margins and making productivity improvements. In 2018 compared to 2017 at comparable properties, worldwide company-operated house profit margins increased by 40 basis points, primarily reflecting RevPAR growth, improved productivity, procurement cost savings, and synergy savings from the Starwood Combination. International company-operated house profit margins increased by 70 basis points, and North American company-operated house profit margins increased by 10 basis points.

System Growth and Pipeline

In 2018, we added 494 properties with 80,255 rooms around the world across our portfolio of brands. Approximately 45 percent of the added rooms are located outside North America, and 12 percent are conversions from competitor brands. In 2018, 107 properties (21,176 rooms) exited our system.

At year-end 2018, our development pipeline grew to a record 478,000 rooms, with more than half located outside of North America. The pipeline includes hotel rooms under construction and under signed contracts, and nearly 23,000 hotel rooms approved for development but not yet under signed contracts. In 2018, we signed management and franchise agreements for 816 properties (125,000 rooms), setting company records for rooms signings in Europe and Middle East and Africa and hotel signings in Asia Pacific. Contracts signed in 2018 also reflected the Company’s strength in the industry’s highest tier, with 29 properties (6,200 rooms) signed across six luxury brands.

In 2019, we expect the number of our open hotel rooms will increase approximately 5.5 percent net, reflecting room exits of 1.0 to 1.5 percent.