Financial Information
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
BUSINESS AND OVERVIEW
Lodging Business
We are a worldwide operator, franchisor, and licensor of hotels and timeshare properties in 74 countries and territories under numerous brand names. We also develop, operate, and market residential properties and provide services to home/condominium owner associations. At year-end 2012, we had 3,801 properties (660,394 rooms) in our system, including 35 home and condominium products (3,927 units) for which we manage the related owners’ associations. At year-end 2012, we grouped our operations into four business segments: North American Full-Service Lodging, North American Limited-Service Lodging, International Lodging, and Luxury Lodging.
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 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 noncontrollable expenses such as insurance, real estate taxes, capital spending reserves, and the like.
We use or license our trademarks for the sale of residential real estate either in conjunction with hotel development or on a stand-alone basis under our The Ritz-Carlton, EDITION, JW Marriott, Autograph Collection, and Marriott brand names. Third-party developers typically build and sell residences with little, if any, of our capital at risk. While the worldwide residential market is very large, the luxurious nature of our residential properties, the quality and exclusivity associated with our brands, and the hospitality services that we provide, all serve to make our residential properties distinctive.
Under our business model, we typically manage or franchise hotels, rather than own them. At year-end 2012, we operated 43 percent of the hotel rooms in our worldwide system under management agreements, our franchisees operated 54 percent under franchise agreements, unconsolidated joint ventures that we have an interest in held management and provided services to franchised properties for 1 percent, and we owned or leased only 2 percent.
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 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, and of our associated mobile smartphone applications 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. In 2012, we introduced Marriott.jp, adding Japanese language capability to our online platforms. Together with Spanish, German, French, and Chinese, our guests now have a wider selection of languages with which to discover our properties online.
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 believe RevPAR, which we calculate by dividing room sales for comparable properties by room nights available to guests 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. 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 believe 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, 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.
Lodging Results
Conditions for our lodging business continued to improve in 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. Demand was strong in most North American markets, constrained somewhat in Washington, D.C. due to weak government demand associated with government spending restrictions and a shorter congressional calendar. The D.C. market also experienced the customarily lower demand levels in 2012 associated with an election year, although leisure and group business were strong in the summer months.
In Europe, many economies continue to struggle although our properties there benefited from strong international arrivals. In addition, our hotels benefited from the Olympic Games in London, the Euro Cup Soccer Championship in Warsaw, and a strong fair calendar in Germany. Demand was weak in European markets more dependent on regional travel and new supply constrained RevPAR growth in a few European markets. Demand was strong in the United Arab Emirates and improved modestly but remained weak in Egypt, Jordan, Kuwait, and Oman. Demand in the Asia Pacific region continued to be strong particularly for properties in Thailand, China, and Indonesia. Demand in China in 2012 moderated somewhat as the year progressed, reflecting declines in government related travel ahead of the country’s change in leadership, moderating economic growth, and new supply in several markets. RevPAR in India softened throughout 2012, reflecting the country’s more challenging economic environment and increased supply.
Compared to 2011, 2012 worldwide average daily rates increased 3.9 percent on a constant dollar basis to $137.49 for comparable systemwide properties, RevPAR increased 6.1 percent to $97.34, and occupancy increased 1.5 percentage points to 70.8 percent.
We monitor market conditions and carefully price our rooms daily in accordance with individual hotel demand levels, generally increasing room rates as demand increases. We also modify the mix of our business to increase revenue as demand changes. Demand for higher rated rooms improved in most markets in 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 pursue productivity improvements.
The hotels in our system serve both transient and group customers. Overall, business transient and leisure transient demand was strong in 2012. Group demand improved in 2012, group customers spent more on their meetings, and group related property-level food and beverage volumes improved. Additionally, we saw an increase in short-term bookings for both large and small groups during 2012, and attendance at meetings frequently exceeded initial projections. 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. Projected group revenue for 2013 for comparable North American Marriott Hotels & Resorts properties is up six percent year-over-year, with more than half of the growth coming from rate.
Negotiated corporate business (“special corporate business”) represented nearly 15 percent of our full-service managed hotel room nights for 2012 in North America. In negotiating pricing for this segment of business, we do not focus strictly on volume, but instead carefully evaluate the relationship with our business customers, including for example, stay patterns (day of week and season), locations of stays, non-room spend, and aggregate spend in order to maximize property-level earnings. For 2013, we expect to complete negotiations with our special corporate business national-accounts clients in the first quarter. With approximately 85 percent of our negotiations complete, on average room rates for comparable customers are approximately five percent higher in 2013 than the prior year.
Lodging Transactions
On October 1, 2012, we acquired the Gaylord brand and hotel management company from Gaylord Entertainment Company (now called Ryman Hospitality Properties, Inc. (“Ryman Hospitality”) for $210 million. Ryman Hospitality continues to own the Gaylord hotels, which we manage under the Gaylord brand under long-term management agreements. This transaction added four hotels and approximately 7,800 rooms to our North American Full-Service segment, and included our entering into management agreements for several attractions at the Gaylord Opryland in Nashville, consisting of a showboat, a golf course, and a saloon. As part of the transaction, on December 1, 2012, we also assumed management of another hotel owned by Ryman Hospitality, the Inn at Opryland, with approximately 300 rooms.
In 2012, 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.
In 2012, we completed the sale of our 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 2012, we recognized a gain of $41 million, which consisted of: (1) $20 million for the recognition of the 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 for the gain on the sale of the equity interest. We also recognized base management fee revenue totaling $7 million in 2012, primarily that we had deferred in earlier periods, but which we earned in conjunction with the sale.
See Footnote No. 7, “Acquisitions and Dispositions” to our Financial Statements 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 MVW. Under license agreements with us, MVW is both the exclusive developer and operator of timeshare, fractional, and related products under the Marriott brand and the exclusive developer of fractional and related products under The Ritz-Carlton brand. We now earn license fees under these 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.
Before the spin-off, we recorded a pre-tax noncash impairment charge of $324 million ($234 million after-tax) in our 2011 Income Statement under the “Timeshare strategy-impairment charges” caption. Please see Footnote No. 16, “Spin-off,” to our Financial Statements and “Risk Factors; Other Risks” for more information on the spin-off and the impairment charges.