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 134 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. In January 2020, we modified our reportable segment structure as a result of a change in the way management intends to evaluate results and allocate resources within the Company. Beginning with the first quarter of 2020, we will present the following reportable business segments: North America; Asia Pacific; and Europe, Middle East, and Africa. Our Caribbean and Latin America operating segment will be included in a combined Caribbean and Latin America and “Unallocated corporate” caption.

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 property 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 Tours & Activities 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, Loyalty Program, multichannel reservation systems, and desirable property amenities. We strive to effectively leverage our size and broad distribution. We believe that our Loyalty Program generates substantial repeat business that might otherwise go to competing hotels, and we strategically market to the program’s large and growing member base to generate revenue.

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 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 Starwood reservations database is no longer used for business operations.

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

In July 2019, the ICO issued a formal notice of intent under the U.K. Data Protection Act 2018 proposing a fine in the amount of £99 million against the Company in relation to the Data Security Incident (the “Proposed ICO Fine”). We mutually agreed with the ICO to an extension of the regulatory process until June 1, 2020 and the ICO proceeding is ongoing. In the 2019 second quarter, we recorded an accrual in the full amount of the Proposed ICO Fine for this loss contingency, and in the 2019 fourth quarter, we reduced the accrual to $65 million based on the ongoing proceeding. See Note 7 for additional information.

We are currently unable to estimate the range of total possible financial impact to the Company from the Data Security Incident in excess of the expenses already incurred. However, we do not believe this incident will impact our long-term financial health. Although our insurance program includes coverage designed to limit our exposure to losses such as those related to the Data Security Incident, that insurance may not be sufficient or available to cover all of our expenses or other losses (including fines and penalties) related to the Data Security Incident. As we expected, the cost of such insurance increased for our current policy period, and the cost of such insurance could continue to increase in 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 (including possible fines and penalties), increased expenses and capital investments for information technology and information security and data privacy, and increased expenses for compliance activities and to meet increased legal and regulatory requirements. See Note 7 for information related to expenses incurred in 2018 and 2019, 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, and should not be viewed as necessarily correlating with our fee revenue. 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. 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 that were open and operating under one of our brands since the beginning of the last full calendar year (since January 1, 2018 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 2019 compared to 2018, we had 4,371 comparable North American properties and 1,232 comparable International properties. For 2018 compared to 2017, we had 4,109 comparable North American properties and 1,173 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 2019 full-year results reflected a year-over-year increase in the number of properties in our system, strong demand for our brands in many markets around the world, and generally favorable economic conditions. Comparable worldwide systemwide RevPAR for 2019 increased 1.3 percent to $117.30, ADR increased 0.8 percent on a constant dollar basis to $160.55, and occupancy increased 0.4 percentage points to 73.1 percent, compared to 2018.

In North America, RevPAR increased modestly in 2019, driven by higher ADR, partially constrained by new lodging supply in certain markets. In our Asia Pacific segment in 2019, RevPAR growth was driven by India and major urban markets in Greater China but was partially constrained by lower demand in Hong Kong. Our Europe region experienced higher demand in 2019, led by strong demand from U.S. travelers in the U.K., Italy, and Spain. In our Middle East and Africa region, RevPAR remained relatively stable in 2019 due to RevPAR growth in Africa, partially offset by ongoing geopolitical and economic instability and supply growth in the Middle East. RevPAR grew across our Caribbean and Latin America region, driven by higher ADR, partially constrained by lower demand in Mexico.

For our company-operated properties, we continue to focus on enhancing property-level house profit margins and making productivity improvements. North American company-operated house profit margins decreased by 20 basis points in 2019 compared to 2018 at comparable properties, primarily due to wage increases and modest RevPAR growth, partially offset by cost controls and synergy savings from the Starwood Combination. International company-operated house profit margins increased by 20 basis points in 2019 compared to 2018 at comparable properties, primarily due to RevPAR growth in our Asia Pacific segment and Europe region and cost controls and synergy savings from the Starwood Combination.

The Coronavirus outbreak currently is impacting our operations in China and other parts of our Asia Pacific segment by necessitating the closure of numerous hotels in mainland China and significantly reducing demand in Greater China and certain other Asia Pacific markets. We cannot presently estimate the overall operational and financial impact, which could be material to our 2020 results, and which is highly dependent on the breadth and duration of the outbreak and could be affected by other factors we are not currently able to predict.

System Growth and Pipeline

In 2019, we added 516 properties with 78,142 rooms around the world across our portfolio of brands. Approximately 44 percent of added rooms are located outside North America, and 18 percent are conversions from competitor brands. In 2019, 70 properties (11,908 rooms) exited our system.

At year-end 2019, our development pipeline grew to a record 515,000 rooms, with more than half located outside of North America. The pipeline includes hotel rooms under construction and under signed contracts, and approximately 23,000 hotel rooms approved for development but not yet under signed contracts. In 2019, we signed management and franchise agreements for 815 properties (136,000 rooms), setting company records for rooms signings in Asia Pacific, Europe, Caribbean and Latin America, and Middle East and Africa. Contracts signed in 2019 also reflected the Company’s strength in the luxury tier, with 42 properties signed across 27 countries and territories.

In 2020, we expect the number of our open hotel rooms will increase at a rate consistent with our recent experience. This growth expectation does not include any potential impact related to the Coronavirus outbreak.