MAR-Q3.2014-10Q



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 30, 2014
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: 283,360,811 shares of Class A Common Stock, par value $0.01 per share, outstanding at October 17, 2014.





MARRIOTT INTERNATIONAL, INC.
FORM 10-Q TABLE OF CONTENTS
 
 
 
Page No.
 
 
 
Part I.
 
 
 
 
Item 1.
 
 
 
 
 
Condensed Consolidated Statements of Income -
Three and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
Three and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
as of September 30, 2014 and December 31, 2013
 
 
 
 
Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.



Item 5.
 
 
 
Item 6.
 
 
 
 



1


PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

MARRIOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
($ in millions, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014

September 30, 2013
 
September 30, 2014
 
September 30, 2013
REVENUES
 
 
 
 
 
 
 
Base management fees
$
178

 
$
150

 
$
509

 
$
469

Franchise fees
203

 
175

 
560

 
503

Incentive management fees
67

 
53

 
220

 
183

Owned, leased, and other revenue
244

 
220

 
747

 
690

Cost reimbursements
2,768

 
2,562

 
8,201

 
7,720

 
3,460

 
3,160

 
10,237

 
9,565

OPERATING COSTS AND EXPENSES
 
 
 
 
 
 
 
Owned, leased, and other-direct
189

 
172

 
573

 
532

Reimbursed costs
2,768

 
2,562

 
8,201

 
7,720

Depreciation, amortization, and other
33

 
34

 
116

 
92

General, administrative, and other
172

 
147

 
479

 
471

 
3,162

 
2,915

 
9,369

 
8,815

OPERATING INCOME
298

 
245

 
868

 
750

Gains and other income
1

 
1

 
4

 
14

Interest expense
(29
)
 
(28
)
 
(89
)
 
(88
)
Interest income
8

 
5

 
17

 
13

Equity in earnings (losses)
12

 
—

 
6

 
(2
)
INCOME BEFORE INCOME TAXES
290

 
223

 
806

 
687

Provision for income taxes
(98
)
 
(63
)
 
(250
)
 
(212
)
NET INCOME
$
192

 
$
160

 
$
556

 
$
475

EARNINGS PER SHARE-Basic
 
 
 
 
 
 
 
Earnings per share
$
0.66

 
$
0.53

 
$
1.90

 
$
1.55

EARNINGS PER SHARE-Diluted
 
 
 
 
 
 
 
Earnings per share
$
0.65

 
$
0.52

 
$
1.86

 
$
1.51

CASH DIVIDENDS DECLARED PER SHARE
$
0.20

 
$
0.17

 
$
0.57

 
$
0.47

See Notes to Condensed Consolidated Financial Statements.

2


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

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Net income
$
192

 
$
160

 
$
556

 
$
475

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
(18
)
 
11

 
(18
)
 
(2
)
Other derivative instrument adjustments, net of tax
3

 
(6
)
 
4

 
—

Unrealized gain on available-for-sale securities, net of tax
—

 
—

 
2

 
4

Reclassification of losses (gains), net of tax
1

 
—

 
3

 
(7
)
Total other comprehensive income (loss), net of tax
(14
)
 
5

 
(9
)
 
(5
)
Comprehensive income
$
178

 
$
165

 
$
547

 
$
470


See Notes to Condensed Consolidated Financial Statements.


3


MARRIOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in millions)
 
 
(Unaudited)
 
 
 
September 30,
2014
 
December 31,
2013
ASSETS
 
 
 
Current assets
 
 
 
Cash and equivalents
$
150

 
$
126

Accounts and notes receivable, net
1,030

 
1,081

Current deferred taxes, net
207

 
252

Prepaid expenses
54

 
67

Other
111

 
27

Assets held for sale
—

 
350

 
1,552

 
1,903

Property and equipment, net
1,736

 
1,543

Intangible assets
 
 
 
Goodwill
894

 
874

Contract acquisition costs and other
1,342

 
1,131

 
2,236

 
2,005

Equity and cost method investments
234

 
222

Notes receivable, net
215

 
142

Deferred taxes, net
597

 
647

Other
277

 
332

 
$
6,847

 
$
6,794

LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current liabilities
 
 
 
Current portion of long-term debt
$
7

 
$
6

Accounts payable
612

 
557

Accrued payroll and benefits
759

 
817

Liability for guest loyalty programs
657

 
666

Other
703

 
629

 
2,738

 
2,675

Long-term debt
3,521

 
3,147

Liability for guest loyalty programs
1,561

 
1,475

Other long-term liabilities
869

 
912

Shareholders’ deficit
 
 
 
Class A Common Stock
5

 
5

Additional paid-in-capital
2,753

 
2,716

Retained earnings
4,156

 
3,837

Treasury stock, at cost
(8,703
)
 
(7,929
)
Accumulated other comprehensive loss
(53
)
 
(44
)
 
(1,842
)
 
(1,415
)
 
$
6,847

 
$
6,794


See Notes to Condensed Consolidated Financial Statements.

4


MARRIOTT INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions)
(Unaudited)
 
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2013
OPERATING ACTIVITIES
 
 
 
Net income
$
556

 
$
475

Adjustments to reconcile to cash provided by operating activities:
 
 
 
Depreciation, amortization, and other
116

 
92

Share-based compensation
81

 
89

Income taxes
83

 
67

Liability for guest loyalty programs
70

 
5

Working capital changes
(37
)
 
35

Other
81

 
42

                       Net cash provided by operating activities
950

 
805

INVESTING ACTIVITIES
 
 
 
Capital expenditures
(267
)
 
(226
)
Dispositions
292

 
—

Loan advances
(103
)
 
(5
)
Loan collections
26

 
62

Equity and cost method investments
(7
)
 
(16
)
Contract acquisition costs
(47
)
 
(36
)
Acquisition of a business, net of cash acquired
(184
)
 
—

Other
(14
)
 
(88
)
                        Net cash used in investing activities
(304
)
 
(309
)
FINANCING ACTIVITIES
 
 
 
Commercial paper/Credit Facility, net
375

 
268

Issuance of long-term debt
—

 
345

Repayment of long-term debt
(5
)
 
(405
)
Issuance of Class A Common Stock
129

 
141

Dividends paid
(167
)
 
(144
)
Purchase of treasury stock
(954
)
 
(644
)
       Other
—

 
(1
)
                        Net cash used in financing activities
(622
)
 
(440
)
INCREASE IN CASH AND EQUIVALENTS
24

 
56

CASH AND EQUIVALENTS, beginning of period
126

 
88

CASH AND EQUIVALENTS, end of period
$
150

 
$
144

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,” “our,” “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.” In addition, references throughout to numbered “Footnotes” refer to the numbered Notes in these Notes to Condensed Consolidated Financial Statements, unless otherwise noted.
During the 2014 first quarter, we modified the information that our President and Chief Executive Officer, who is our “chief operating decision maker” (“CODM”), reviews to be consistent with our continent structure. This structure aligns our business around geographic regions and is designed to enable us to operate more efficiently and to accelerate worldwide growth. We changed our operating segments to reflect this continent structure and have revised our prior period business segment information accordingly. See Footnote No. 11, “Business Segments.”
Beginning with the 2014 first quarter, we reclassified amounts attributable to depreciation and amortization that we previously reported under the “General, administrative, and other” and “Owned, leased, and other-direct” captions of our Consolidated Statements of Income and presented these amounts in a separate “Depreciation, amortization, and other” caption. We continue to report depreciation amounts that third party owners reimburse to us under “Reimbursed costs” in our Consolidated Statements of Income. In addition, in our Consolidated Statements of Cash Flows, we reclassified depreciation that third party owners reimburse to us from the “Depreciation, amortization, and other” caption to the “Other” caption. We have reclassified the prior period amounts presented to conform to our 2014 presentation of these items.
These 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”). The financial statements in this report should be read in conjunction with the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (“2013 Form 10-K”). Certain terms not otherwise defined in this Form 10-Q have the meanings specified in our 2013 Form 10-K.
Preparation of financial statements that conform with GAAP requires that we 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 our disclosures of contingencies. We base these estimates on historical experience and on various other assumptions that we consider reasonable under the circumstances. Actual results could differ from these estimates.
In 2013, we changed our financial reporting cycle to a calendar year-end reporting cycle and an end-of-month quarterly reporting cycle. Accordingly, our 2013 fiscal year began on December 29, 2012 (the day after the end of the 2012 fiscal year) and ended on December 31, 2013, and our 2013 quarters include the three month periods ended March 31, June 30, September 30, and December 31, except that the period ended March 31, 2013 also included December 29, 2012 through December 31, 2012.
The table below shows the reporting periods as we refer to them in this report, their date ranges, and the number of days in each. As shown below, our 2014 first three quarters had three fewer days of activity than our 2013 first three quarters. Our 2014 fiscal year will also have three fewer days of activity than our 2013 fiscal year.

6


Reporting Period
Date Range
Number of Days
2014 third quarter
July 1, 2014 - September 30, 2014
92
2013 third quarter
July 1, 2013 - September 30, 2013
92
2014 first three quarters
January 1, 2014 - September 30, 2014
273
2013 first three quarters
December 29, 2012 - September 30, 2013
276
2014
January 1, 2014 - December 31, 2014
365
2013
December 29, 2012 - December 31, 2013
368
Our Financial Statements reflect all normal and recurring adjustments necessary to present fairly our financial position as of September 30, 2014, and December 31, 2013, the results of our operations for the three and nine months ended September 30, 2014, and September 30, 2013, and cash flows for the nine months ended September 30, 2014, and September 30, 2013. 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.
New Accounting Standards
Accounting Standards Update No. 2014-09 - “Revenue from Contracts with Customers” (“ASU No. 2014-09”)
ASU No. 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, as well as most industry-specific guidance, and significantly enhances comparability of revenue recognition practices across entities and industries by providing a principles-based, comprehensive framework for addressing revenue recognition issues. In order for a provider of promised goods or services to recognize as revenue the consideration that it expects to receive in exchange for the promised goods or services, the provider should apply the following five steps: (1) identify the contract with a customer(s); (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU No. 2014-09 also specifies the accounting for some costs to obtain or fulfill a contract with a customer and provides enhanced disclosure requirements. ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, which for us will be our 2017 first quarter. We are permitted to use the retrospective or modified retrospective method when adopting ASU No. 2014-09. We are still assessing the impact that ASU No. 2014-09 will have on our financial statements and disclosures.

2.
INCOME TAXES
Our effective tax rate increased from 28.1% to 33.9% for the three months ended September 30, 2014 primarily due to higher pre-tax earnings in the U.S. which are taxed at a higher rate, unrealized foreign exchange gains that were taxed within a foreign jurisdiction, and a favorable 2013 foreign tax true-up not recurring in 2014. Our effective tax rate increased from 30.8% to 31.0% for the nine months ended September 30, 2014 primarily as a result of higher pre-tax earnings in the U.S. which are taxed at a higher rate, unrealized foreign exchange gains that were taxed within a foreign jurisdiction, favorable benefits recognized in 2013 due to retroactive provisions of the American Taxpayer Relief Act of 2012, and other favorable 2013 foreign true-ups that did not recur in 2014. This increase in the effective tax rate for the nine months ended September 30, 2014 was partially offset by a $21 million benefit from the favorable resolution in 2014 of an issue with U.S. federal taxing authorities related to guest marketing.
For the 2014 third quarter, our unrecognized tax benefits balance of $14 million remained unchanged from the 2014 second quarter. For the 2014 first three quarters, our unrecognized tax benefits balance decreased by $20 million from year-end 2013. The unrecognized tax benefits balance included $12 million of tax positions that, if recognized, would impact our effective tax rate.
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

7


for tax years through 2009. We participate in the IRS Compliance Assurance Program, which accelerates IRS examination of key transactions with the goal of resolving any issues before the taxpayer files its return. As a result, the audits of our open tax years 2010 through 2013 are complete, including all matters that could affect the Company's cash tax benefits related to our spin-off in 2011 of our timeshare operations and timeshare development business, while the 2014 tax year audit is currently ongoing. Various foreign, state, and local income tax returns are also under examination by the applicable taxing authorities.
We paid cash for income taxes, net of refunds, of $105 million in the 2014 first three quarters and $51 million in the 2013 first three quarters.

3.
SHARE-BASED COMPENSATION
Under our Stock and Cash Incentive Plan (the “Stock Plan”), we award: (1) stock options (our “Stock Option Program”) to purchase our Class A Common Stock (“common stock”); (2) stock appreciation rights (“SARs”) for our common stock (our “SAR Program”); (3) restricted stock units (“RSUs”) of our common stock; and (4) deferred stock units. We grant awards at exercise prices or strike prices that equal the market price of our common stock on the date of grant.
We recorded share-based compensation expense for award grants of $28 million for the 2014 third quarter, $28 million for the 2013 third quarter, $81 million for the 2014 first three quarters, and $89 million for the 2013 first three quarters. Deferred compensation costs related to unvested awards totaled $137 million at September 30, 2014 and $108 million at December 31, 2013.
RSUs
We granted 1.9 million RSUs during the 2014 first three quarters to certain officers and key employees, and those units vest generally over four years in equal annual installments commencing one year after the grant date. We also granted 0.2 million performance-based RSUs (“PSUs”) during the 2014 first three quarters to certain named executive officers and their direct reports, subject to the satisfaction of certain performance conditions over, or at the end of, a three-year vesting period. RSUs, including PSUs, granted in the 2014 first three quarters had a weighted average grant-date fair value of $51.
SARs and Stock Options
We granted 0.3 million SARs and 0.1 million stock options to officers, key employees, and non-employee directors during the 2014 first three quarters. These SARs and options generally expire ten years after the grant date 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 grant date. The weighted average grant-date fair value of SARs granted in the 2014 first three quarters was $17 and the weighted average exercise price was $53. The weighted average grant-date fair value of stock options granted in the 2014 first three quarters was $17 and the weighted average exercise price was $53.    
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 this more flexible binomial model provides a better estimate of the fair value of our options and SARs because it takes into account employee and non-employee director exercise behavior based on changes in the price of our stock and also allows us to use other dynamic assumptions.

8



We used the following assumptions to determine the fair value of the SARs and stock options we granted during the 2014 first three quarters:
Expected volatility
29-30%
Dividend yield
1.14%
Risk-free rate
2.2-2.8%
Expected term (in years)
6-10
In making these assumptions, we base expected volatility on the historical movement of Marriott's stock price. 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 an 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 and non-employee directors. 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. In recent years, non-employee directors have generally exercised grants in their last year of exercisability.
Other Information
As of the end of the 2014 third quarter, we had authorized 27 million shares under the Stock Plan, including 7 million shares under the Stock Option Program and the SAR Program.

4.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 noncurrent financial assets and liabilities that qualify as financial instruments, determined under current guidance for disclosures on the fair value of financial instruments, in the following table:
 
At September 30, 2014
 
At December 31, 2013
($ in millions)
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Senior, mezzanine, and other loans
$
215

 
$
216

 
$
142

 
$
145

Marketable securities and other debt securities
44

 
44

 
111

 
111

Total long-term financial assets
$
259

 
$
260

 
$
253

 
$
256

 
 
 
 
 
 
 
 
Senior Notes
$
(2,188
)
 
$
(2,292
)
 
$
(2,185
)
 
$
(2,302
)
Commercial paper
(1,211
)
 
(1,211
)
 
(834
)
 
(834
)
Other long-term debt
(117
)
 
(122
)
 
(123
)
 
(124
)
Other long-term liabilities
(57
)
 
(57
)
 
(50
)
 
(50
)
Total long-term financial liabilities
$
(3,573
)
 
$
(3,682
)
 
$
(3,192
)
 
$
(3,310
)
We estimate the fair value of our senior, mezzanine, and other loans, including the current portion, by discounting cash flows using risk-adjusted rates, both of which are Level 3 inputs.
We carry our marketable securities at fair value. Our marketable securities include 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, which we value using directly observable Level 1 inputs. The carrying value of these marketable securities at the end of our 2014 third quarter was $44 million.

9


In the 2013 second quarter, we received $22 million in net cash proceeds for the sale of a portion of our shares of a publicly traded company (with an amortized cost of $14 million at the date of sale) and recognized an $8 million gain in the “Gains and other income”caption of our Income Statements. This gain included recognition of unrealized gains that we recorded in other comprehensive income as of the end of the 2013 first quarter. See Footnote No. 12, “Comprehensive Income and Shareholders' (Deficit) Equity”of the 2013 Form 10-K for additional information on our reclassification of these unrealized gains from accumulated other comprehensive income.
We estimate the fair value of our other long-term debt, including the current portion and 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. As noted in Footnote No. 8, “Long-term Debt,” even though our commercial paper borrowings generally have short-term maturities of 30 days or less, we classify outstanding commercial paper borrowings as long-term based on our ability and intent to refinance them on a long-term basis. As we are a frequent issuer of commercial paper, we use pricing from recent transactions as Level 2 inputs in estimating fair value. At the end of the 2014 third quarter and year-end 2013, we determined that the carrying value of our commercial paper approximated its fair value due to the short maturity. Our other long-term liabilities largely consist of guarantees. As noted in Footnote No. 10, “Contingencies,” we measure our liability for guarantees at fair value on a nonrecurring basis, that is when we issue or modify a guarantee, using Level 3 internally developed inputs. At the end of the 2014 third quarter and year-end 2013, we determined that the carrying values of our guarantee liabilities approximated their fair values based on Level 3 inputs.
See the “Fair Value Measurements” caption of Footnote No. 1, “Summary of Significant Accounting Policies” of our 2013 Form 10-K for more information on the input levels we use in determining fair value.

5.
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:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
(in millions, except per share amounts)
 
 
 
 
 
 
 
Computation of Basic Earnings Per Share
 
 
 
 
 
 
 
Net income
$
192

 
$
160

 
$
556

 
$
475

Weighted average shares outstanding
288.9

 
301.9

 
292.5

 
306.8

Basic earnings per share
$
0.66

 
$
0.53

 
$
1.90

 
$
1.55

Computation of Diluted Earnings Per Share
 
 
 
 
 
 
 
Net income
$
192

 
$
160

 
$
556

 
$
475

Weighted average shares outstanding
288.9

 
301.9

 
292.5

 
306.8

Effect of dilutive securities
 
 
 
 
 
 
 
Employee stock option and SARs plans
2.9

 
3.8

 
3.2

 
4.1

Deferred stock incentive plans
0.7

 
0.8

 
0.7

 
0.8

Restricted stock units
2.9

 
3.0

 
3.0

 
3.1

Shares for diluted earnings per share
295.4

 
309.5

 
299.4

 
314.8

Diluted earnings per share
$
0.65

 
$
0.52

 
$
1.86

 
$
1.51

We compute the effect of dilutive securities using the treasury stock method and average market prices during the period. We have excluded antidilutive stock options and SARs from our calculation of diluted earnings per share of 0.4 million for both the 2013 third quarter and first three quarters because their exercise prices were greater than the average market prices. We had no antidilutive stock options and SARs for both the 2014 third quarter and first three quarters.

10



6.
PROPERTY AND EQUIPMENT
The following table shows the composition of our property and equipment balances at the end of the 2014 third quarter and year-end 2013: 
 
At Period End
($ in millions)
September 30,
2014
 
December 31,
2013
Land
$
541

 
$
535

Buildings and leasehold improvements
771

 
786

Furniture and equipment
774

 
789

Construction in progress
566

 
338

 
2,652

 
2,448

Accumulated depreciation
(916
)
 
(905
)
 
$
1,736

 
$
1,543

See Footnote No. 12, “Acquisitions and Dispositions” for information on a $25 million impairment charge we recorded in the 2014 first half on three EDITION hotels in the “Depreciation, amortization, and other”caption of our Income Statements.

7.
NOTES RECEIVABLE
The following table shows the composition of our notes receivable balances (net of reserves and unamortized discounts) at the end of the 2014 third quarter and year-end 2013:
 
At Period End
($ in millions)
September 30,
2014
 
December 31,
2013
Senior, mezzanine, and other loans
$
241

 
$
178

Less current portion
(26
)
 
(36
)
 
$
215

 
$
142

We do not have any past due notes receivable amounts at the end of the 2014 third quarter. In the 2014 second quarter, we provided an $85 million mezzanine loan (net of a $15 million discount) to an owner in conjunction with entering into a franchise agreement for an International property. The following table shows the expected future principal payments (net of reserves and unamortized discounts) as well as interest rates for our notes receivable as of the end of the 2014 third quarter:
 
Notes Receivable Principal Payments (net of reserves and unamortized discounts) and Interest Rates ($ in millions)
 
Amount
2014
 
$
7

2015
 
88

2016
 
2

2017
 
2

2018
 
3

Thereafter
 
139

Balance at September 30, 2014
 
$
241

Weighted average interest rate at September 30, 2014
 
6.1
%
Range of stated interest rates at September 30, 2014
 
0 - 9%


11


The following table shows the unamortized discounts for our notes receivable at the end of the 2014 third quarter and year-end 2013:
Notes Receivable Unamortized Discounts ($ in millions)
 
Total
Balance at year-end 2013
 
$
12

Balance at September 30, 2014
 
$
26

At the end of the 2014 third quarter, our recorded investment in impaired notes receivable was $108 million, and we had a $95 million reserve for credit losses, leaving $13 million of our investment in impaired loans for which we had no related allowance. At year-end 2013, our recorded investment in impaired notes receivable was $99 million, and we had a $90 million reserve for credit losses, leaving $9 million of our investment in impaired loans for which we had no related allowance. The activity related to our notes receivable reserve during the 2014 first three quarters consisted of an increase to fully reserve for recorded interest on an impaired note receivable. Our average investment in impaired notes receivable totaled $108 million for the 2014 third quarter, $104 million for the 2014 first three quarters, $104 million for the 2013 third quarter and $98 million for the 2013 first three quarters.
 
8.
LONG-TERM DEBT
We provide detail on our long-term debt balances in the following table as of the end of the 2014 third quarter and year-end 2013:
 
At Period End
($ in millions)
September 30,
2014
 
December 31,
2013
Senior Notes:
 
 
 
Series G, interest rate of 5.8%, face amount of $316, maturing November 10, 2015
(effective interest rate of 6.6%)(1)
$
313

 
$
312

Series H, interest rate of 6.2%, face amount of $289, maturing June 15, 2016
(effective interest rate of 6.3%)(1)
289

 
289

Series I, interest rate of 6.4%, face amount of $293, maturing June 15, 2017
(effective interest rate of 6.5%)(1)
293

 
292

Series K, interest rate of 3.0%, face amount of $600, maturing March 1, 2019
(effective interest rate of 4.4%)(1)
596

 
595

Series L, interest rate of 3.3%, face amount of $350, maturing September 15, 2022
(effective interest rate of 3.4%)(1)
349

 
349

Series M, interest rate of 3.4%, face amount of $350, maturing October 15, 2020
(effective interest rate of 3.6%)(1)
348

 
348

Commercial paper, average interest rate of 0.3% at September 30, 2014
1,211

 
834

$2,000 Credit Facility
—

 
—

Other
129

 
180

 
3,528

 
3,199

Less current portion classified in:
 
 
 
Other current liabilities (liabilities held for sale)
—

 
(46
)
Current portion of long-term debt
(7
)
 
(6
)
 
$
3,521

 
$
3,147

 
(1) 
Face amount and effective interest rate are as of September 30, 2014.
We are a party to a multicurrency revolving credit agreement (the “Credit Facility”) that provides for $2,000 million of aggregate borrowings to support general corporate needs, including working capital, capital expenditures, share repurchases, and letters of credit. The availability of the Credit Facility also supports our commercial paper program. Borrowings under the Credit Facility generally 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 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

12


ability and intent to refinance the outstanding borrowings on a long-term basis. The Credit Facility expires on July 18, 2018. See the “Cash Requirements and Our Credit Facilities” caption later in this report in the “Liquidity and Capital Resources” section for information on our available borrowing capacity at September 30, 2014.
We show future principal payments for our debt as of the end of the 2014 third quarter in the following table:
Debt Principal Payments ($ in millions)
 
Amount
2014
 
$
2

2015
 
321

2016
 
297

2017
 
301

2018
 
1,220

Thereafter
 
1,387

Balance at September 30, 2014
 
$
3,528

All of our long-term debt is recourse to us but unsecured. We paid cash for interest, net of amounts capitalized, of $49 million in the 2014 first three quarters and $58 million in the 2013 first three quarters.
Early in the 2014 fourth quarter, we issued $400 million aggregate principal amount of 3.1 percent Series N Notes due 2021 (the “Series N Notes”). We received net proceeds of approximately $394 million from the offering, after deducting the underwriting discount and estimated expenses. We will pay interest on the Series N Notes on April 15 and October 15 of each year, commencing on April 15, 2015. The notes will mature on October 15, 2021, and we may redeem them, in whole or in part, at our option, under the terms provided in the form of Note. We issued the Series N 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.

9.
COMPREHENSIVE INCOME AND SHAREHOLDERS' (DEFICIT) EQUITY
The following table details the accumulated other comprehensive (loss) income activity for the 2014 first three quarters:
($ in millions)
Foreign Currency Translation Adjustments
 
Other Derivative Instrument Adjustments
 
Unrealized Gains on Available-For-Sale Securities
 
Accumulated Other Comprehensive (Loss) Income
Balance at year-end 2013
$
(31
)
 
$
(19
)
 
$
6

 
$
(44
)
Other comprehensive (loss) income before reclassifications (1)
(18
)
 
4

 
2

 
(12
)
Amounts reclassified from accumulated other comprehensive loss
—

 
3

 
—

 
3

Net other comprehensive (loss) income
(18
)
 
7

 
2

 
(9
)
Balance at September 30, 2014
$
(49
)
 
$
(12
)
 
$
8

 
$
(53
)
(1) 
We present the portions of other comprehensive income before reclassifications for the 2014 first three quarters that relate to unrealized gains on available-for-sale securities net of $1 million of deferred taxes.







13


The following table details the changes in common shares outstanding and shareholders’ deficit for the 2014 first three quarters:
(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) Income
298.0

 
Balance at year-end 2013
$
(1,415
)
 
$
5

 
$
2,716

 
$
3,837

 
$
(7,929
)
 
$
(44
)
—

 
Net income
556

 
—

 
—

 
556

 
—

 
—

—

 
Other comprehensive income
(9
)
 
—

 
—

 
—

 
—

 
(9
)
—

 
Cash dividends ($0.5700 per share)
(167
)
 
—

 
—

 
(167
)
 
—

 
—

5.4

 
Employee stock plan issuance
149

 
—

 
37

 
(70
)
 
182

 
—

(16.5
)
 
Purchase of treasury stock
(956
)
 
—

 
—

 
—

 
(956
)
 
—

286.9

 
Balance at September 30, 2014
$
(1,842
)
 
$
5

 
$
2,753

 
$
4,156

 
$
(8,703
)
 
$
(53
)

10.
CONTINGENCIES
Guarantees
We issue guarantees to certain lenders and hotel owners, chiefly to obtain long-term management contracts. The guarantees generally have a stated maximum funding amount 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 and record our liability for the fair value of a guarantee on a nonrecurring basis, that is when we issue or modify a guarantee, 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 the following assumptions, among others: 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 primarily market comparable data and assumptions about market capitalization rates, credit spreads, growth rates, and inflation.
We show the maximum potential amount of our future guarantee fundings and the carrying amount of our liability for guarantees for which we are the primary obligor at September 30, 2014 in the following table:
($ in millions)
Guarantee Type
Maximum Potential
Amount  of Future Fundings
 
Liability for  Guarantees
Debt service
$
51

 
$
14

Operating profit
78

 
38

Other
15

 
1

Total guarantees where we are the primary obligor
$
144

 
$
53

We included our liability for guarantees at September 30, 2014, for which we are the primary obligor, on our Balance Sheet in “Other long-term liabilities.”
Of the guarantees listed in the preceding table, $13 million of debt service guarantees, $17 million of operating profit guarantees, and $1 million of other guarantees will not be in effect until the underlying properties open and we begin to operate them or certain other events occur.

14


Not included in the table above is a “put option” agreement we entered into in the 2014 first quarter but which is not currently in effect with the lenders for a construction loan. In conjunction with entering into a management agreement for the Times Square EDITION hotel in New York City (currently projected to open in 2017), and the hotel's ownership group obtaining acquisition financing and entering into agreements concerning future construction financing for the mixed use project (which includes both the hotel and adjacent retail space), we agreed in the first quarter of 2014 to provide credit support to the lenders through a “put option” agreement. Under this agreement, we granted the lenders the right, upon an uncured event of default by the hotel owner under, and an acceleration of, the mortgage loan, to require us to purchase the hotel component of the property during the first two years after opening for $315 million. Because we would acquire the building upon exercise of the put option, we have not included the amount in the table above. The lenders may extend this period for up to three years to complete foreclosure if the loan has been accelerated and certain other conditions are met. We do not expect that the lenders will exercise this put option. We have no ownership interest in this hotel.
The preceding table also does not include the following guarantees:
•
$87 million of guarantees for Senior Living Services lease obligations of $64 million (expiring in 2018) and lifecare bonds of $23 million (estimated to expire in 2019), for which we are secondarily liable. Sunrise Senior Living, Inc. (“Sunrise”) is the primary obligor on both the leases and $4 million of the lifecare bonds; HCP, Inc., as successor by merger to CNL Retirement Properties, Inc. (“CNL”), is the primary obligor on $19 million of the 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 for these guarantees had a carrying value of $3 million at September 30, 2014. 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 $1 million of cash collateral and an $85 million letter of credit issued by Key Bank to secure our exposure under the lease guarantees and certain other obligations of Sunrise. The letter of credit balance was $75 million at the end of the 2014 third quarter, which decreased as a result of lease payments made and lifecare bonds redeemed. During the extension term, Sunrise agreed to make an annual payment to us from 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 in 1997, consisting of annual rent payments of approximately $6 million and total remaining rent payments through the initial term of approximately $28 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 $4 million (€3 million) of which remained at September 30, 2014. 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 Marriott Vacations Worldwide Corporation (“MVW”) payment obligations, for which we currently have a total exposure of $13 million, relate to two guarantees. MVW has indemnified us for these obligations. At the end of the 2014 third quarter, we expect these obligations will expire as follows: $3 million in 2018, and $10 million (12 million Singapore Dollars) 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 $1 million at September 30, 2014.
•
A guarantee for a lease, originally entered into in 2000, for which we became secondarily liable in 2012 as a result of our sale of the ExecuStay corporate housing business to Oakwood Worldwide (“Oakwood”). Oakwood has indemnified us for the obligations under this guarantee. Our total exposure at the end of the 2014 third quarter for this guarantee is $6 million in future rent payments through the end of the lease in 2019. Our liability for this guarantee had a carrying value of $1 million at September 30, 2014.

15


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 we note in the preceding paragraphs, as of September 30, 2014, we had the following commitments outstanding:
•
A commitment to invest up to $8 million of equity for a non-controlling interest in a partnership that plans 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 $2 million of this commitment in 2015. We do not expect to fund the remaining $6 million of this commitment.
•
A commitment to invest up to $23 million of equity for non-controlling interests in a partnership that plans to purchase or develop limited-service properties in Asia. We expect to fund this commitment as follows: $3 million in 2015 and $6 million in 2016. We do not expect to fund the remaining $14 million of this commitment prior to the end of the commitment period in 2016.
•
A commitment, with no expiration date, to invest up to $11 million in a joint venture for development of a new property. We expect to fund this commitment in 2015.
•
A commitment to invest $7 million in the renovation of a leased hotel. We expect to fund this commitment by the end of 2014.
•
We have a right and under certain circumstances an obligation to acquire our joint venture partner’s remaining interests in two joint ventures over the next seven years at a price based on the performance of the ventures. In conjunction with this contingent obligation, we advanced $19 million (€15 million) in deposits, $14 million (€11 million) of which is remaining. The amounts on deposit are refundable to the extent we do not acquire our joint venture partner’s remaining interests.
•
Various commitments for the purchase of information technology hardware, software, as well as accounting, finance, and maintenance services in the normal course of business totaling $86 million. We expect to fund these commitments as follows: $64 million in 2014, $17 million in 2015, and $5 million in 2016 and thereafter. The majority of these commitments will be recovered through cost reimbursement charges to properties in our system.
•
Several commitments aggregating $33 million with no expiration date and which we do not expect to fund.
•
A commitment to invest up to $10 million under certain circumstances for additional mandatorily redeemable preferred equity ownership interest in an entity that owns three hotels. We may fund this commitment, which expires in 2015 subject to annual extensions through 2018; however, we have not yet determined the amount or timing of any potential funding.
•
A $9 million loan commitment that we extended to the owner of a property to cover the cost of renovation shortfalls which we expect to fund in 2015. The commitment will expire at the end of the 2016 second quarter.
At September 30, 2014, we had $77 million of letters of credit outstanding (all outside the Credit Facility), the majority of which were for our self-insurance programs. Surety bonds issued as of September 30, 2014, totaled $143 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

16


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. The plaintiffs seek damages, 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 remaining named plaintiffs. The parties completed limited discovery concerning Marriott's defense of statute of limitations with respect to Mr. Bond and Mr. Steigman and concerning class certification. We opposed plaintiffs' motion for class certification and sought summary judgment on the issue of statute of limitations in 2012. On August 9, 2013, the court denied our motion for summary judgment on the issue of statute of limitations and deferred its ruling on class certification. We moved to amend the court's judgment on our motion for summary judgment in order to certify an interlocutory appeal, which was denied. On January 7, 2014, the court denied plaintiffs' motion for class certification, and issued a Scheduling Order for full discovery of the remaining issues in this case. The parties completed full discovery and filed cross motions for summary judgment, with a final reply brief to be filed by plaintiffs by December 8, 2014, and a hearing on all motions scheduled for January 12, 2015. 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 the full impact of an adverse judgment and the possibility of our prevailing on our statute of limitations defense on appeal 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. Since then, the KFTC has conducted additional fact-gathering at those two hotels and also has collected information from another Marriott managed hotel located in Seoul. We understand that the KFTC also has sought documents from numerous other hotels in Seoul and other parts of Korea 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.

11.
BUSINESS SEGMENTS
We are a diversified global lodging company. During the 2014 first quarter, we modified the information that our President and Chief Executive Officer, who is our CODM, reviews to be consistent with our continent structure. This structure aligns our business around geographic regions and is designed to enable us to operate more efficiently and to accelerate worldwide growth. As a result of modifying our reporting information, we revised our operating segments to eliminate our former Luxury segment, which we allocated between our existing North American Full-Service operating segment, and the following four new operating segments: Asia Pacific, Caribbean and Latin America, Europe, and Middle East and Africa.
Although our North American Full-Service and North American Limited-Service segments meet the applicable accounting criteria to be reportable business segments, our four new operating segments do not meet the criteria for separate disclosure as reportable business segments. Accordingly, we combined our four new operating segments into an “all other” category which we refer to as “International” and have revised our prior period business segment information to conform to our new business segment presentation.
As of the end of the 2014 third quarter, our three reportable business segments include the following brands:
•
North American Full-Service: Marriott Hotels, Marriott Conference Centers, JW Marriott, Renaissance Hotels, Renaissance ClubSport, Gaylord Hotels, The Ritz-Carlton (together with residential properties associated with some of The Ritz-Carlton hotels), and Autograph Collection properties located in the United States and Canada;
•
North American Limited-Service: Courtyard, Fairfield Inn & Suites, SpringHill Suites, Residence Inn, and TownePlace Suites properties located in the United States and Canada;

17


•
International: Marriott Hotels, JW Marriott, Renaissance Hotels, Autograph Collection, Courtyard, AC Hotels by Marriott, Fairfield Inn & Suites, Residence Inn, The Ritz-Carlton (together with residential properties associated with some of The Ritz-Carlton hotels), Bulgari Hotels & Resorts, EDITION, Protea Hotels, Moxy Hotels, and Marriott Executive Apartments properties located outside the United States and Canada.
We evaluate the performance of our business segments based largely 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, and divisional general, administrative, and other expenses to each of our segments. “Other unallocated corporate” represents a 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. It also includes license fees we receive from our credit card programs and license fees from MVW. Our CODM monitors assets for the consolidated company but does not use assets by business segment when assessing performance or making business segment resource allocations.
Revenues
 
 
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30, 2014

September 30, 2013
 
September 30, 2014
 
September 30, 2013
North American Full-Service Segment
$
2,042

 
$
1,910

 
$
6,190

 
$
5,965

North American Limited-Service Segment
806

 
690

 
2,223

 
1,957

International Segment
546

 
491

 
1,634

 
1,444

Total segment revenues
3,394

 
3,091

 
10,047

 
9,366

Other unallocated corporate
66

 
69

 
190

 
199

 
$
3,460

 
$
3,160

 
$
10,237

 
$
9,565

Net Income
 
 
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
North American Full-Service Segment
$
122

 
$
105

 
$
407

 
$
373

North American Limited-Service Segment
177

 
131

 
443

 
372

International Segment
62

 
53

 
201

 
158

Total segment financial results
361

 
289

 
1,051

 
903

Other unallocated corporate
(50
)
 
(43
)
 
(173
)
 
(141
)
Interest expense and interest income
(21
)
 
(23
)
 
(72
)
 
(75
)
Income taxes
(98
)
 
(63
)
 
(250
)
 
(212
)
 
$
192

 
$
160

 
$
556

 
$
475

As a result of the changes to our operating segments discussed above, in the 2014 first quarter we reallocated goodwill among our affected reporting units based on the relative fair value of each remaining or newly identified reporting unit. We also determined that the estimated fair value of each reporting unit exceeded its carrying amount. The following table shows the reclassification of goodwill we previously associated with our former Luxury segment to our North American Full-Service and International segments. The table also reflects goodwill added as a result of our acquisition of the Protea Hotel Group's brands and hotel management business in the 2014 second quarter. See Footnote No. 12, “Acquisitions and Dispositions” for more information.


18


Goodwill
($ in millions)
North American
Full-Service
Segment
 
North American
Limited-Service
Segment
 
International
Segment
 
Former Luxury
Segment
 
Total
Goodwill
Year-end 2013 balance:
 
 
 
 
 
 
 
 
 
Goodwill
$
335

 
$
125

 
$
298

 
$
170

 
$
928

Accumulated impairment losses
—

 
(54
)
 
—

 
—

 
(54
)
 
$
335

 
$
71

 
$
298

 
$
170

 
$
874

 
 
 
 
 
 
 
 
 
 
Segment reclassifications
$
57

 
$
—

 
$
113

 
$
(170
)
 
$
—

Additions
—

 
—

 
20

 
—

 
20

 
 
 
 
 
 
 
 
 
 
September 30, 2014 balance:
 
 
 
 
 
 
 
 
 
Goodwill
$
392

 
$
125

 
$
431

 
$
—

 
$
948

Accumulated impairment losses
—

 
(54
)
 
—

 
—

 
(54
)
 
$
392

 
$
71

 
$
431

 
$
—

 
$
894


12.
ACQUISITIONS AND DISPOSITIONS

2014 Acquisitions

In the 2014 second quarter, we acquired the Protea Hotel Group's brands and hotel management business (“Protea Hotels”) for $193 million (ZAR 2.046 billion) in cash and recognized approximately: $184 million (ZAR 1.943 billion) in intangible assets, consisting of deferred contract acquisition costs of $91 million (ZAR 960 million), a brand intangible of $73 million (ZAR 772 million), and goodwill of $20 million (ZAR 211 million); and $9 million (ZAR 103 million) of tangible assets consisting of property and equipment, equity method investments, and other current assets at the acquisition date. As part of the transaction, Protea Hospitality Holdings created an independent property ownership company that retained ownership of the hotels Protea Hospitality Holdings formerly owned, and entered into long-term management and lease agreements with Marriott for these hotels. The property ownership company also retained a number of minority interests in other Protea-managed hotels. As a result of the transaction, we added 113 hotels (10,016 rooms) across three brands in South Africa and six other Sub-Saharan African countries to our International segment portfolio and currently manage 45 percent, franchise 39 percent, and lease 16 percent of those rooms.

2014 Dispositions

In the 2014 first quarter, we sold The London EDITION to a third party, received approximately $230 million in cash, and simultaneously entered into definitive agreements to sell The Miami and The New York EDITION hotels that we are currently developing to the same third party. The total sales price for the three EDITION hotels will be approximately $816 million. We expect to sell The Miami EDITION during the fourth quarter of 2014 and The New York EDITION in the first half of 2015, when we anticipate that construction will be complete. We will retain long-term management agreements for each of the three hotels sold. We did not reclassify The Miami EDITION or The New York EDITION assets and liabilities as held for sale because the hotels are under construction and not available for immediate sale in their present condition. During the first three quarters of 2014, we evaluated the three hotels for recovery and, in the first half of 2014, recorded a $25 million impairment charge, primarily attributable to The Miami EDITION, in the “Depreciation, amortization, and other” caption of our Income Statements as our cost estimates exceed our total fixed sales price. Of the $25 million impairment charge, $15 million relates to a reallocation of costs between The Miami EDITION hotel and residential components (the residential components are not included in the sale). We did not allocate that charge to any of our segments.
In the 2014 first quarter, we sold our right to acquire the landlord’s interest in a leased real estate property and certain attached assets of the property, consisting of $106 million (€77 million) in property and equipment and $48

19

million (€35 million) in liabilities. We received $62 million (€45 million) in cash and transferred $45 million (€33 million) of related obligations. We continue to operate the property under a long-term management agreement.

20


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.
Any number of risks and uncertainties could cause actual results to differ materially from those we express in our forward-looking statements, including the risks and uncertainties we describe 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 statement. 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.

21


BUSINESS AND OVERVIEW
We are a worldwide operator, franchisor, and licensor of hotels and timeshare properties in 79 countries and territories under numerous brand names. We also develop, operate, and market residential properties and provide services to home/condominium owner associations. At the end of the 2014 third quarter, we had 4,127 properties (702,254 rooms) in our system, including 40 home and condominium products (4,228 units) for which we manage the related owners’ associations.
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 management fees and non-controllable expenses such as insurance, real estate taxes, and capital spending reserves.
Under our business model, we typically manage or franchise hotels, rather than own them. At September 30, 2014, we operated 42 percent of the hotel rooms in our worldwide system under management agreements; our franchisees operated 55 percent under franchise agreements; and we owned or leased only two percent. The remaining one percent represented our interest in unconsolidated joint ventures that manage hotels and provide services to franchised properties.
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 drives growth while minimizing 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 enhances 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 of desirable brands.
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 our 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.
Performance Measures
We believe Revenue per Available Room (“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 statistics, including occupancy and average daily rate, throughout this report, for the 2013 first three quarters reflect the calendar period from January 1, 2013 to September 30, 2013. For the properties located in countries that use

22


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.
Our comparable properties are generally those that were open and operating under one of our brands for at least one full calendar year as of the end of the current period and have not, in either the current or previous periods presented, (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 percentage of our properties on September 30, 2014 and September 30, 2013, respectively: (1) 88% and 92% of North American properties; (2) 60% and 66% of International properties; and (3) 84% and 88% of total properties.
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 net of 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 our management fees, furniture, fixtures and equipment replacement reserves, insurance, taxes, or other fixed expenses.
Operating Results
Our 2014 first three quarters results reflected a favorable economic climate in many markets around the world, low supply growth in most markets in the U.S. and Europe, improved pricing due to higher occupancies in most markets globally, and a year-over-year increase in the number of properties in our system. For the three months ended September 30, 2014, comparable worldwide systemwide RevPAR increased 8.1 percent to $114.29, average daily rates increased 4.5 percent on a constant dollar basis to $148.55, and occupancy increased 2.6 percentage points to 76.9 percent, compared to the same period a year ago. For the nine months ended September 30, 2014, comparable worldwide systemwide RevPAR increased 6.7 percent to $111.64, average daily rates increased 3.7 percent on a constant dollar basis to $150.00, and occupancy increased 2.1 percentage points to 74.4 percent, compared to the same period a year ago.
Strong U.S. group business demand contributed to increased rate growth in the 2014 first three quarters. Transient demand continued to be strong in the western U.S. in the 2014 first three quarters, and was stronger in the third quarter in the eastern U.S. when compared to the first half of the year, as we eliminated discounts, shifted business into higher rated price categories, and raised room rates. In New York City, new lodging supply continued to constrain rate growth, while in Washington D.C., demand strengthened in the third quarter due to increased city-wide events and a favorable comparison to the 2013 government sequestration.
Bookings for future group business in the U.S. improved in the 2014 first three quarters. For group business, two-thirds is typically booked before the year of arrival and one-third is booked in the year of arrival. As of the end of the 2014 third quarter, the group revenue pace for company-operated Marriott Hotels brand properties in North America was up about five percent for stays in 2014, compared to 2013 third quarter booking pace for stays in 2013, reflecting improved group demand and greater pricing power.
In Europe, the United Kingdom and Central Europe experienced strong demand in the 2014 first three quarters primarily due to increased business travel and special events, while in France results reflected the impact of a weaker economy. Eastern Europe experienced lower demand, constrained by continued economic deterioration due to the Russia/Ukraine conflict. In the Middle East and Africa, demand was stronger in Egypt due to improved political stability. Demand continued to be strong in Bahrain and Jordan, but weakened from new supply in the United Arab Emirates and remained weak in Kuwait due to reduced government spending. The Asia Pacific region continued to experience strong demand within Japan, Indonesia, India, and most of Greater China, benefiting from increased special corporate and transient business. New supply continued to constrain growth in certain markets in Southern China. In the 2014 first three quarters,Thailand demand was weak due to political instability, although the

23


declines moderated in the third quarter. In the Caribbean and Latin America, strong demand throughout the region in the 2014 first three quarters was driven by leisure travel to our resorts. Brazil also benefited from the World Cup.
We monitor market conditions and carefully price our rooms daily in accordance with individual property demand levels, generally adjusting room rates as demand changes. We also modify the mix of our business to increase revenue as demand changes. Demand for higher rated rooms improved in most markets in the 2014 first three quarters, which allowed us to reduce discounting and special offers in many markets. This mix improvement benefited average daily rates. For our company-operated properties, we continue to focus on enhancing property-level house profit margins and actively pursue productivity improvements.
System Growth and Pipeline
During the 2014 first three quarters, we added 31,475 rooms (gross) to our system, including 10,016 rooms related to the Protea Hotels acquisition. Approximately 59 percent of new rooms are located outside the United States, and 7 percent of the room additions are conversions from competitor brands. At the end of the 2014 third quarter, we had nearly 225,000 rooms in our lodging development pipeline, which includes hotel rooms under construction and under signed contracts and also includes approximately 37,000 hotel rooms approved for development but not yet under signed contracts. We expect the number of our hotel rooms (gross) will increase by approximately 7 percent in 2014, including the addition of rooms associated with the Protea Hotels transaction, and approximately 6 percent, net of deletions. The figures in this paragraph do not include residential or timeshare units.
Change in Reporting Cycle
As further detailed in Footnote No. 1, “Basis of Presentation,” beginning with our 2013 fiscal year, we changed our financial reporting cycle to a calendar year-end reporting cycle and an end-of-month quarterly reporting cycle. The table below shows the reporting periods as we refer to them in this report, their date ranges, and the number of days in each. As shown below, our 2014 first three quarters had three fewer days of activity than our 2013 first three quarters and our 2014 fiscal year will have three fewer days of activity than our 2013 fiscal year.
Reporting Period
Date Range
Number of Days
2014 third quarter
July 1, 2014 - September 30, 2014
92
2013 third quarter
July 1, 2013 - September 30, 2013
92
2014 first three quarters
January 1, 2014 - September 30, 2014
273
2013 first three quarters
December 29, 2012 - September 30, 2013
276
2014
January 1, 2014 - December 31, 2014
365
2013
December 29, 2012 - December 31, 2013
368
We discuss the estimated impact of the three fewer days of activity in our 2014 first three quarters within the “Revenues” and “Operating Income” sections of this report.


24


CONSOLIDATED RESULTS
The following discussion presents our analysis of the significant items of the results of our operations for the 2014 third quarter compared to the 2013 third quarter, and the 2014 first three quarters compared to the 2013 first three quarters.
Revenues
Third Quarter. Revenues increased by $300 million (9 percent) to $3,460 million in the 2014 third quarter from $3,160 million in the 2013 third quarter as a result of higher cost reimbursements revenue ($206 million), higher base management fees ($28 million), higher franchise fees ($28 million), higher owned, leased, and other revenue ($24 million), and higher incentive management fees ($14 million).
Cost reimbursements revenue represents reimbursements of costs incurred on behalf of managed, franchised, and licensed 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, reservations, and marketing 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. The $206 million increase in total cost reimbursements revenue, to $2,768 million in the 2014 third quarter from $2,562 million in the 2013 third quarter, reflected the impact of higher occupancies at our properties and growth across the system. Since the end of the 2013 third quarter, our managed rooms increased by 6,980 rooms and our franchised rooms increased by 23,188 rooms, net of hotels exiting the system.
The $28 million increase in total base management fees, to $178 million in the 2014 third quarter from $150 million in the 2013 third quarter, reflected increased recognition of previously deferred fees ($13 million), stronger RevPAR due to increased demand ($10 million), and the impact of unit growth across the system ($8 million), partially offset by lower fees due to properties that converted from managed to franchised ($3 million). The $28 million increase in total franchise fees, to $203 million in the 2014 third quarter from $175 million in the 2013 third quarter, reflected stronger RevPAR due to increased demand ($11 million), the impact of unit growth across the system ($11 million), increased relicensing transactions ($5 million), and fees from properties that converted to franchised from managed ($2 million). The $14 million increase in total incentive management fees, to $67 million in the 2014 third quarter from $53 million in the 2013 third quarter largely reflected higher net house profit at North American managed hotels.
The $24 million increase in owned, leased, and other revenue, to $244 million in the 2014 third quarter from $220 million in the 2013 third quarter, predominantly reflected $18 million of higher owned and leased revenue, and $5 million in revenues from various Protea Hotels programs. Higher owned and leased revenue reflected $14 million from Protea Hotel leases associated with the acquisition, $8 million in revenue from a North American Full-Service managed property we acquired in the 2013 fourth quarter, and stronger performance across our remaining owned and leased properties primarily from the International segment, partially offset by $7 million attributable to three International segment properties that converted to managed or franchised properties during 2014.
First Three Quarters. Revenues increased by $672 million (7 percent) to $10,237 million in the 2014 first three quarters from $9,565 million in the 2013 first three quarters as a result of higher cost reimbursements revenue ($481 million), higher franchise fees ($57 million), higher owned, leased, and other revenue ($57 million), higher base management fees ($40 million), and higher incentive management fees ($37 million). We estimate that the three fewer days of activity in the 2014 first three quarters compared to the 2013 first three quarters reduced fee revenues by approximately $5 million.
The $481 million increase in total cost reimbursements revenue, to $8,201 million in the 2014 first three quarters from $7,720 million in the 2013 first three quarters, reflected the impact of higher occupancies at our properties and growth across the system.
The $40 million increase in total base management fees, to $509 million in the 2014 first three quarters from $469 million in the 2013 first three quarters, largely reflected stronger RevPAR due to increased demand ($24 million), the impact of unit growth across the system ($18 million), and increased recognition of previously

25


deferred fees ($15 million), partially offset by terminated units ($7 million), decreased fees due to properties that converted from managed to franchised ($7 million), unfavorable foreign exchange rates ($5 million), and three fewer days of activity ($2 million). The $57 million increase in total franchise fees, to $560 million in the 2014 first three quarters from $503 million in the 2013 first three quarters, reflected stronger RevPAR due to increased demand ($28 million), new unit growth across the system ($25 million), fees from properties that converted to franchised from managed ($6 million), and increased relicensing fees ($6 million), partially offset by terminated units ($4 million) and three fewer days of activity ($3 million). The $37 million increase in total incentive management fees, to $220 million in the 2014 first three quarters from $183 million in the 2013 first three quarters, largely reflected higher net house profit at North American and International managed hotels and unit growth in International markets.
The $57 million increase in owned, leased, and other revenue, to $747 million in the 2014 first three quarters from $690 million in the 2013 first three quarters, predominantly reflected $55 million of higher owned and leased revenue, $10 million in revenue from various Protea Hotels programs, $4 million in higher branding fees, and $2 million in brand sponsored training, partially offset by $17 million lower termination fee revenue in 2014. Higher owned and leased revenue reflected $28 million from Protea Hotel leases associated with the acquisition, $24 million in revenue from a North American Full-Service managed property that we acquired in the 2013 fourth quarter, and stronger performance across our remaining owned and leased properties primarily from the International segment, partially offset by $22 million attributable to five International segment properties that converted to managed or franchised properties.
Operating Income
Third Quarter. Operating income increased by $53 million to $298 million in the 2014 third quarter from $245 million in the 2013 third quarter. The $53 million increase in operating income reflected a $28 million increase in base management fees, a $28 million increase in franchise fees, a $14 million increase in incentive management fees, and $7 million of higher owned, leased, and other revenue, net of direct expenses, partially offset by a $25 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 compared to the 2013 third quarter in the preceding “Revenues” section.
The $7 million (15 percent) increase in owned, leased, and other revenue, net of direct expenses was largely attributable to $5 million of higher owned and leased revenue, net of direct expenses and $1 million from various programs at Protea Hotels. Higher owned and leased revenue, net of direct expenses of $5 million reflects $3 million of revenue, net of direct expenses for a North American Full-Service managed property that we acquired in the 2013 fourth quarter, and $2 million of revenue, net of direct expenses for Protea Hotel leases associated with the acquisition.
General, administrative, and other expenses increased by $25 million, primarily reflecting $5 million in higher compensation and employee-related expenses, $4 million from net unfavorable foreign exchange rates, $4 million of higher litigation expenses, $4 million from the addition of Protea Hotels and related transition costs, $3 million of property related expenses including reserves for guarantee funding and bad debt reserves, and $2 million for a lease reserve. Total general, administrative, and other expenses included $12 million in increases that we did not allocate to any of our segments, and $13 million in increases that we allocated as follows: $1 million increase to our North American Full-Service segment, $2 million increase to our North American Limited-Service segment, and $10 million increase to our International segment.
First Three Quarters. Operating income increased by $118 million to $868 million in the 2014 first three quarters from $750 million in the 2013 first three quarters. The $118 million increase in operating income reflected a $57 million increase in franchise fees, a $40 million increase in base management fees, a $37 million increase in incentive management fees, and $16 million of higher owned, leased, and other revenue, net of direct expenses, partially offset by a $24 million increase in depreciation, amortization, and other expense and a $8 million increase in general, administrative, and other expenses. We estimate that the three fewer days of activity in the 2014 first three quarters compared to the 2013 first three quarters reduced fee revenues by approximately $5 million. We

26


discuss the reasons for the increases in base management fees, franchise fees, and incentive management fees compared to the 2013 first three quarters in the preceding “Revenues” section.
The $16 million (10 percent) increase in owned, leased, and other revenue, net of direct expenses was largely attributable to $21 million of higher owned and leased revenue, net of direct expenses and $4 million in higher branding fees, $3 million from various programs at Protea Hotels, and $2 million in brand sponsored training, partially offset by $17 million in higher termination fees in 2013. Higher owned and leased revenue, net of direct expenses of $21 million primarily reflects $13 million in net favorable results at several leased properties, $10 million of revenue, net of direct expenses for a North American Full-Service managed property that we acquired in the 2013 fourth quarter, and $3 million of revenue, net of direct expenses for new Protea Hotel leases, partially offset by $4 million attributable to International segment properties that converted to managed or franchised.
Depreciation, amortization and other expense increased by $24 million (26 percent) to $116 million in the 2014 first three quarters from $92 million in the 2013 first three quarters. The increase reflected the $25 million net impairment charge on the EDITION hotels discussed in Footnote No. 12, “Acquisitions and Dispositions,” $4 million in higher accelerated amortization related to contract terminations, $3 million in higher depreciation related to a North American Full-Service property that we acquired in the 2013 fourth quarter, and $3 million in higher contract amortization primarily from Protea Hotels, partially offset by $8 million of accelerated amortization related to contract terminations in 2013 and $4 million of 2013 depreciation for two International properties that converted to managed contracts.
General, administrative, and other expenses increased by $8 million (2 percent) to $479 million in the 2014 first three quarters from $471 million in the 2013 first three quarters. The increase largely reflected $8 million from net unfavorable foreign exchange rates, $9 million from the addition of Protea Hotels and related transition costs, and $2 million for a lease reserve, partially offset by a $5 million performance cure payment in 2013 for an International segment property, $3 million in lower professional fees, and $2 million in lower development expense. The $8 million increase in total general, administrative, and other expenses included $1 million in increases that we did not allocate to any of our segments, and $7 million in increases that we allocated as follows: $2 million increase to our North American Full-Service segment, $1 million increase to our North American Limited-Service segment, and $4 million increase to our International segment.
Gains and Other Income
 
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30, 2014
September 30, 2013
 
September 30, 2014
September 30, 2013
Gains on sales of real estate and other
$
1

$
1

 
$
4

$
4

Gain on sale of joint venture and other investments
—

—

 
—

9

Income from cost method joint ventures
—

—

 
—

1

 
$
1

$
1

 
$
4

$
14

Third Quarter. Gains and other income was unchanged compared to the 2013 third quarter.
First Three Quarters. Gains and other income decreased by $10 million (71 percent) to $4 million in the 2014 first three quarters compared to $14 million in the 2013 first three quarters. This decrease in gains and other income primarily reflected a gain of $8 million on the sale of a portion of our shares of a publicly traded company in the 2013 second quarter. See Footnote No. 4, “Fair Value of Financial Instruments” for additional information on the sale.
Interest Income
Third Quarter. Interest income increased by $3 million (60 percent) to $8 million in the 2014 third quarter compared to $5 million in the 2013 third quarter. The increase was due to $3 million earned on the $85 million mezzanine loan (net of a $15 million discount) provided to an owner in conjunction with entering into a franchise

27


agreement for an International property in the 2014 second quarter. See Footnote No.7, “Notes Receivable” for more information on the loan.
First Three Quarters. Interest income increased by $4 million (31 percent) to $17 million in the 2014 first three quarters compared to $13 million in the 2013 first three quarters. The increase was primarily due to $3 million earned on the $85 million mezzanine loan described in the preceding “Third Quarter” discussion, and $2 million earned on the $65 million mandatorily redeemable preferred equity ownership interest acquired in the 2013 second quarter.
Equity in Earnings (Losses)
Third Quarter. Equity in earnings of $12 million in the 2014 third quarter increased by $12 million from equity in earnings of zero in the 2013 third quarter, primarily driven by a $9 million reversal of deferred tax liabilities associated with a tax law change in a country in which two of our International joint ventures operate.
First Three Quarters. Equity in earnings of $6 million in the 2014 first three quarters increased by $8 million from equity in earnings of $2 million in the 2013 first three quarters. The increase was driven by a $9 million reversal of deferred tax liabilities described in the preceding “Third Quarter” discussion, $6 million in increased earnings at two of our International joint ventures, and a favorable variance from a $4 million impairment charge in the 2013 second quarter associated with a corporate investment (not allocated to any of our segments) that we determined was fully impaired because we do not expect to recover the investment. This was partially offset by an $11 million litigation reserve associated with another corporate investment (not allocated to any of our segments).
Provision for Income Tax
Third Quarter. Provision for income tax increased by $35 million (56 percent) to $98 million in the 2014 third quarter compared to $63 million in the 2013 third quarter. The increase was primarily due to higher pre-tax earnings, unrealized foreign exchange gains that were taxed within a foreign jurisdiction, and non-recurring favorable foreign tax true-ups in the 2013 third quarter.
First Three Quarters. Provision for income tax increased by $38 million (18 percent) to $250 million in the 2014 first three quarters compared to $212 million in the 2013 first three quarters. The increase was primarily due to higher pre-tax earnings, unrealized foreign exchange gains that were taxed within a foreign jurisdiction, favorable benefits recognized in 2013 due to retroactive provisions of the American Taxpayer Relief Act of 2012, and non-recurring favorable foreign true-ups in the 2013 first three quarters. The increase was partially offset by the favorable resolution of a U.S. federal tax issue relating to a guest marketing program in the 2014 first three quarters.
Net Income
Third Quarter. Net income increased by $32 million to $192 million in the 2014 third quarter from $160 million in the 2013 third quarter, and diluted earnings per share increased by $0.13 per share (25 percent) to $0.65 per share in the 2014 third quarter from $0.52 per share in the 2013 third quarter. As discussed in more detail in the preceding sections beginning with “Revenues” or as shown in the Income Statements, the $32 million increase in net income compared to the year-ago quarter was due to higher base management fees ($28 million), higher franchise fees ($28 million), higher incentive management fees ($14 million), higher equity in earnings ($12 million), higher owned, leased, and other revenue, net of direct expenses ($7 million), and higher interest income ($3 million). These changes were partially offset by higher income taxes ($35 million) and higher general, administrative, and other expense ($25 million).
First Three Quarters. Net income increased by $81 million to $556 million in the 2014 first three quarters from $475 million in the 2013 first three quarters, and diluted earnings per share increased by $0.35 per share (23 percent) to $1.86 per share in the 2014 first three quarters from $1.51 per share in the 2013 first three quarters. As discussed in more detail in the preceding sections beginning with “Revenues” or as shown in the Income Statements, the $81 million increase in net income compared to the year-ago quarter was due to higher franchise fees ($57 million), higher base management fees ($40 million), higher incentive management fees ($37 million), higher owned, leased, and other revenue, net of direct expenses ($16 million), higher equity in earnings ($8 million), and higher interest income ($4 million). These increases were partially offset by higher depreciation,

28


amortization, and other expense ($24 million), higher general, administrative, and other expenses ($8 million), lower gains and other income ($10 million), and higher income taxes ($38 million).
Earnings Before Interest Expense, Taxes, Depreciation and Amortization (“EBITDA”) and Adjusted EBITDA
EBITDA, a financial measure that is not required by, or presented in accordance with United States generally accepted accounting principles (“GAAP”), reflects net income excluding the impact of interest expense, provision for income taxes, depreciation and amortization. We believe that EBITDA is a meaningful indicator of operating performance because we use it to measure our ability to service debt, fund capital expenditures, and expand our business. We also use EBITDA, as do analysts, lenders, investors, and others, to evaluate companies because it excludes certain items that can vary widely across different industries or among companies within the same industry. For example, interest expense can be dependent on a company’s capital structure, debt levels, and credit ratings. Accordingly, the impact of interest expense on earnings can vary significantly among companies. The tax positions of companies can also vary because of their differing abilities to take advantage of tax benefits and because of the tax policies of the jurisdictions in which they operate. As a result, effective tax rates and provision for income taxes can vary considerably among companies. EBITDA also excludes depreciation and amortization expense which we report under “Depreciation, amortization, and other” as well as depreciation included under “Reimbursed costs” in our Income Statements, because companies utilize productive assets of different ages and use different methods of both acquiring and depreciating productive assets. These differences can result in considerable variability in the relative costs of productive assets and the depreciation and amortization expense among companies.
We also believe that Adjusted EBITDA, another non-GAAP financial measure, is a meaningful indicator of operating performance. Our Adjusted EBITDA reflects adjustments to exclude 1) pre-tax impairment charges of $10 million in the 2014 first quarter and $15 million in the 2014 second quarter, both of which we recorded in the “Depreciation, amortization, and other” caption of our Income Statements following an evaluation of our EDITION hotels for recovery and determination that our cost estimates exceeded our total fixed sales price, and 2) share-based compensation expense for all periods presented. We excluded share-based compensation expense to address considerable variability among companies in recording compensation expense because companies use share-based payment awards differently, both in the type and quantity of awards granted. We believe that Adjusted EBITDA that excludes these items is a meaningful measure of our operating performance because it permits period-over-period comparisons of our ongoing core operations before these items and facilitates our comparison of results before these items with results from other lodging companies.
EBITDA and Adjusted EBITDA have limitations and should not be considered in isolation or as substitutes for performance measures calculated under GAAP. Both of these non-GAAP measures exclude certain cash expenses that we are obligated to make. In addition, other companies in our industry may calculate EBITDA and in particular Adjusted EBITDA differently than we do or may not calculate them at all, limiting the usefulness of EBITDA and Adjusted EBITDA as comparative measures.
We show our 2014 and 2013 third quarter and first three quarters EBITDA and Adjusted EBITDA calculations that reflect the changes we describe above and reconcile those measures with Net Income in the following table:

29


 
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30, 2014
 
September 30, 2013
 
September 30, 2014
 
September 30, 2013
Net Income
$
192

 
$
160

 
$
556

 
$
475

Interest expense
29

 
28

 
89

 
88

Tax provision
98

 
63

 
250

 
212

Depreciation and amortization
33

 
34

 
91

 
92

Depreciation classified in reimbursed costs
13

 
12

 
38

 
36

Interest expense from unconsolidated joint ventures
—

 
1

 
2

 
3

Depreciation and amortization from unconsolidated joint ventures
1

 
3

 
8

 
9

EBITDA
$
366

 
$
301

 
$
1,034

 
$
915

EDITION impairment charge
—

 
—

 
25

 
—

Share-based compensation (including share-based compensation reimbursed by third-party owners)
27

 
28

 
81

 
89

Adjusted EBITDA
$
393

 
$
329

 
$
1,140

 
$
1,004


30


BUSINESS SEGMENTS
We are a diversified global lodging company. During the 2014 first quarter, we modified the information that our President and Chief Executive Officer reviews to be consistent with our continent structure. This structure aligns our business around geographic regions and is designed to enable us to operate more efficiently and to accelerate worldwide growth. As a result of modifying our reporting information, we revised our operating segments to eliminate our former Luxury segment, which we allocated between our existing North American Full-Service operating segment, and the following four new operating segments: Asia Pacific, Caribbean and Latin America, Europe, and Middle East and Africa.
Although our North American Full-Service and North American Limited-Service segments meet the applicable accounting criteria to be reportable business segments, the four new operating segments do not meet the criteria to be reportable and we combined them into an “all other” category, which we refer to as “International.” We revised prior period business segment information to conform to our new business segment presentation. See Footnote No. 11, “Business Segments,” to our Financial Statements for further information on our segment changes and other information about each segment, including revenues and a reconciliation of segment results to net income.
We added 287 properties (38,995 rooms) and 44 properties (7,099 rooms) exited our system since the end of the 2013 third quarter. These figures do not include residential units. During that time we also added three residential properties (161 units) and no residential properties exited the system.
See the “CONSOLIDATED RESULTS” caption earlier in this report for further information.
Third Quarter. Total segment financial results (as defined in Footnote No. 11, “Business Segments”) increased by $72 million to $361 million in the 2014 third quarter from $289 million in the 2013 third quarter, and total segment revenues increased by $303 million to $3,394 million in the 2014 third quarter, a 10 percent increase from revenues of $3,091 million in the 2013 third quarter.
The quarter-over-quarter increase in segment revenues of $303 million was a result of $212 million of higher cost reimbursements revenue, $28 million of higher base management fees, $28 million of higher franchise fees, $21 million of higher owned, leased, and other revenue, and $14 million of higher incentive management fees. The quarter-over-quarter increase in segment results of $72 million across our business reflected $28 million of higher base management fees, $28 million of higher franchise fees, $14 million of higher incentive management fees, $12 million increase in equity in earnings, and $3 million increase in owned, leased, and other revenue, net of direct expenses, partially offset by a $13 million increase in general, administrative, and other expenses. For more information on the variances see the preceding sections beginning with “Revenues.”
In the 2014 third quarter, 51 percent of our managed properties paid incentive management fees to us versus 32 percent in the 2013 third quarter. Also, 136 North American Limited-Service segment properties, 65 International segment properties and 28 North American Full-Service segment properties, which did not earn any incentive management fees in the year-ago quarter earned a combined $11 million in incentive management fees in the 2014 third quarter. In North America, 40 percent of managed properties paid incentive management fees to us in the 2014 third quarter, compared to 16 percent in the 2013 third quarter. Outside of North America, 68 percent of managed properties paid incentive fees to us in the 2014 third quarter, compared to 64 percent in the 2013 third quarter.
See “Statistics” below for detailed information on Systemwide RevPAR and Company-operated RevPAR by segment, region, and brand.
Compared to the 2013 third quarter, worldwide comparable company-operated house profit margins in the 2014 third quarter increased by 2.0 percentage points and worldwide comparable company-operated house profit per available room (“HP-PAR”) increased by 14.1 percent on a constant U.S. dollar basis, reflecting improvements in both rate and productivity, as well as cost controls. These same factors contributed to North American company-operated house profit margins increasing by 2.4 percentage points compared to the 2013 third quarter. HP-PAR at those same properties increased by 16.5 percent. International company-operated house profit margins increased by

31


1.3 percentage points, and HP-PAR at those properties increased by 10.0 percent reflecting increased demand and higher RevPAR in most locations and improved productivity.
First Three Quarters. Total segment financial results increased by $148 million to $1,051 million in the 2014 first three quarters from $903 million in the 2013 first three quarters, and total segment revenues increased by $681 million to $10,047 million in the 2014 first three quarters, a 7 percent increase from revenues of $9,366 million in the 2013 first three quarters.
The year-over-year increase in segment revenues of $681 million was a result of $501 million of higher cost reimbursements revenue, a $57 million increase in franchise fees, $46 million of higher owned, leased, and other revenue, $40 million of higher base management fees, and $37 million of higher incentive management fees. The year-over-year increase in segment results of $148 million across our business reflected $57 million of higher franchise fees, $40 million of higher base management fees, $37 million of higher incentive management fees, $16 million increase in equity in earnings, and $5 million increase in owned, leased, and other revenue, net of direct expenses, partially offset by a $7 million increase in general, administrative, and other expenses. For more information on the variances see the preceding sections beginning with “Revenues.”
In the 2014 first three quarters, 55 percent of our managed properties paid incentive management fees to us versus 38 percent in the 2013 first three quarters. Also, 136 North American Limited-Service segment properties, 68 International segment properties and 24 North American Full-Service segment properties, which did not earn any incentive management fees in the 2013 first three quarters earned a combined $18 million in incentive management fees in the 2014 first three quarters. In North America, 45 percent of managed properties paid incentive management fees to us in the 2014 first three quarters, compared to 22 percent in the 2013 first three quarters. Outside of North America, 72 percent of managed properties paid incentive fees to us in the 2014 third quarter, compared to 69 percent in the 2013 third quarter.
Compared to the 2013 first three quarters, worldwide comparable company-operated house profit margins in the 2014 first three quarters increased by 1.3 percentage points and worldwide comparable company-operated HP-PAR increased by 10.2 percent on a constant U.S. dollar basis, reflecting higher occupancy, rate increases, and improved productivity. These same factors contributed to North American company-operated house profit margins increasing by 1.7 percentage points compared to the 2013 first three quarters. HP-PAR at those same properties increased by 12.2 percent. International company-operated house profit margins increased by 0.7 percentage points, and HP-PAR at those properties increased by 6.6 percent reflecting increased demand and higher RevPAR in most locations and improved productivity.

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Summary of Properties by Brand
Including residential properties, we added 49 lodging properties (6,891 rooms) during the 2014 third quarter, while 7 properties (1,279 rooms) exited the system, increasing our total properties to 4,127 (702,254 rooms). These figures include 40 home and condominium products (4,228 units), for which we manage the related owners’ associations.


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At September 30, 2014, we operated, franchised, and licensed the following properties by brand:
 
 
Company-Operated
 
Franchised / Licensed
 
Other (3)
Brand
Properties
 
Rooms
 
Properties
 
Rooms
 
Properties
 
Rooms
U.S. Locations
 
 
 
 
 
 
 
 
 
 
 
Marriott Hotels
129

 
68,330

 
185

 
56,356

 
—

 
—

Marriott Conference Centers
10

 
2,915

 
—

 
—

 
—

 
—

JW Marriott
15

 
9,735

 
8

 
3,239

 
—

 
—

Renaissance Hotels
33

 
15,037

 
43

 
12,358

 
—

 
—

Renaissance ClubSport
—

 
—

 
2

 
349

 
—

 
—

Gaylord Hotels
5

 
8,098

 
—

 
—

 
—

 
—

Autograph Collection
1

 
181

 
34

 
8,817

 
—

 
—

The Ritz-Carlton
38

 
11,300

 
—

 
—

 
—

 
—

The Ritz-Carlton Residences (1)
30

 
3,598

 
—

 
—

 
—

 
—

Courtyard
276

 
43,482

 
582

 
77,107

 
—

 
—

Fairfield Inn & Suites
4

 
1,200

 
703

 
63,213

 
—

 
—

SpringHill Suites
29

 
4,582

 
282

 
32,006

 
—

 
—

Residence Inn
107

 
15,948

 
534

 
61,629

 
—

 
—

TownePlace Suites
17

 
1,933

 
215

 
21,197

 
—

 
—

Timeshare (2)
—

 
—

 
47

 
10,801

 
—

 
—

Total U.S. Locations
694

 
186,339

 
2,635

 
347,072

 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
 
Non-U.S. Locations
 
 
 
 
 
 
 
 
 
 
 
Marriott Hotels
140

 
41,309

 
40

 
11,816

 
—

 
—

JW Marriott
40

 
14,507

 
4

 
1,016

 
—

 
—

Renaissance Hotels
53

 
17,437

 
28

 
7,931

 
—

 
—

Autograph Collection
3

 
584

 
19

 
2,589

 
5

 
348

Moxy Hotels
—

 
—

 
1

 
162

 
—

 
—

Protea Hotels
53

 
6,141

 
59

 
3,966

 
—

 
—

The Ritz-Carlton
47

 
13,777

 
—

 
—

 
—

 
—

The Ritz-Carlton Residences (1)
9

 
575

 
1

 
55

 
—

 
—

The Ritz-Carlton Serviced Apartments
4

 
579

 
—

 
—

 
—

 
—

EDITION
1

 
173

 
1

 
78

 
—

 
—

AC Hotels by Marriott
—

 
—

 
—

 
—

 
75

 
8,499

Bulgari Hotels & Resorts
2

 
117

 
1

 
85

 
—

 
—

Marriott Executive Apartments
27

 
4,285

 
—

 
—

 
—

 
—

Courtyard
66

 
14,254

 
57

 
9,982

 
—

 
—

Fairfield Inn & Suites
1

 
148

 
16

 
1,941

 
—

 
—

SpringHill Suites
—

 
—

 
2

 
299

 
—

 
—

Residence Inn
6

 
749

 
18

 
2,600

 
—

 
—

TownePlace Suites
—

 
—

 
4

 
518

 
—

 
—

Timeshare (2)
—

 
—

 
15

 
2,323

 
—

 
—

Total Non-U.S. Locations
452

 
114,635

 
266

 
45,361

 
80

 
8,847

 
 
 
 
 
 
 
 
 
 
 
 
Total
1,146

 
300,974

 
2,901

 
392,433

 
80

 
8,847

 
(1)
Represents projects where we manage the related owners’ association. We include residential products once they possess a certificate of occupancy.
(2)
Timeshare properties licensed by MVW under the Marriott Vacation Club, The Ritz-Carlton Destination Club, The Ritz-Carlton Residences, and Grand Residences by Marriott brand names. MVW's property and room counts are reported on a period-end basis for the MVW quarter ended September 12, 2014 and includes products that are in active sales as well as those that are sold out.
(3)
Properties operated by unconsolidated joint ventures that hold management agreements and also provide services to franchised properties.


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Total Lodging Properties by Segment
At September 30, 2014, we operated, franchised, and licensed the following properties by segment:
 
 
Total Lodging Properties
 
Properties
 
Rooms
 
U.S.
 
Non-U.S.
 
Total
 
U.S.
 
Non-U.S.
 
Total
North American Full-Service Segment (1)
 
 
 
 
 
 
 
 
 
 
 
Marriott Hotels
314

 
15

 
329

 
124,686

 
5,355

 
130,041